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Rental In For The Long Run

13 Oct, 2005 By: Stephanie Prange

Does rental have a future?

Wall Street has been ready to signal its demise numerous times, with the drumbeat growing louder in the last few months — even as the prognosis for the overall health of the business is getting better.

According to some Wall Street analysts, the future of rental is bleak.

“We do not believe that the vast majority of video stores will be able to survive without adapting to the altered landscape,” wrote Bear Sterns analysts R. Glen Reid and Joseph Holland in reports on the top rental companies released last month.

Online rental services, such as Netflix, will take over a growing share of the business, pushing out brick-and-mortar stores, they wrote. “Given the high fixed costs of the in-store rental business, we believe that prolonged declines will result in an untenable business position for many stores,” they concluded.

Shareholders also are down on the future of the rental market, sending shares of the two big public chains, Movie Gallery and Blockbuster Inc., tumbling to new lows in the wake of steady declines in same-store rentals.

But most in the industry see the business, including brick-and-mortar, lasting, albeit evolving.

Rental still will account for $8.18 billion in consumer spending in 2010, just a tad less than the $8.39 billion consumers are expected to spend in 2005, according to Adams Media Research. The research firm sees subscription rentals growing from $1.35 billion in 2005 to $3.29 billion in 2010, with traditional rental still accounting for $4.89 billion in consumer spending in 2010.

Tom Swasey, spokesperson for online subscription rental leader Netflix, is predictably bullish.

“The company has grown substantially,” he said. “We have 3.2 million subscribers now. We will have 4 million by end of year, 5 million in 2006 and 20 million in the next five to seven years. That's going to come at the cost of stores.”

Brick-and-mortar doomed?

Others think stores aren't going away anytime soon.

“[Online subscription rental] is a very good business model,” said Patrick Fitzgerald, EVP of sales, distribution and new technologies for Buena Vista Home Entertainment. “I think it will continue to grow. I also am not one who thinks brick-and-mortar will go away. Do I think it will be smaller? It could be.”

“Online is a great option for consumers who want to get new releases on a regular basis,” agreed Kelly Sooter, head of domestic home entertainment for DreamWorks. “Other people like to go to stores.”

“There's not going to be a sea change in consumers away from shopping,” added Bo Andersen, president of the Video Software Dealers Association (VSDA).

Many have privately questioned whether the studios have an interest in keeping the rental business alive; their margins in the sellthrough business are much higher.

However, Fitzgerald and Sooter said studios see a place in the market for the rental trade in the future.

“We've always been a really strong proponent of the rental business,” Sooter said. “You just can't ignore a [multibillion dollar] category.”

Steven Scavelli, president of Flash Distributors, thinks that's pretty much the studio feeling.

“I still feel that they know a combo of rental and sellthrough is what's going to make them most profitable,” he said.

Evolution, not desolution

Still, industry observers think rentailers will have to evolve.

“Current rentailers will expand their offering and fill more of the needs of their consumers,” Andersen said. “There will be rental stores, in my view, that transform themselves from specialists into home entertainment marketplaces [offering rental, sellthrough, games and music].”

Andersen also thinks local video stores can crack the rental-by-mail market. “I would hope that they would use their neighborhood location to facilitate the speed and responsiveness,” he said.

Netflix's Swasey doesn't think that will be easy.

“We've seen Blockbuster throw $300 million into it and not show a profit,” he said.

He does, however, think “boutique” businesses — perhaps with a delivery service — may find a niche.

Fitzgerald thinks rentailers are missing the boat on event marketing. “They have a unique ability to really create excitement around an event,” he said. Also, he doesn't buy the idea that rentailers can't do sellthrough. “They can compete,” he said.

Even the chains are having to re-evaluate their models, Sooter said, noting Blockbuster's moves into online rental and campaign to end late fees.

“These kinds of times force them to be smarter and more risky,” she said. “Ultimately, it ends up being a good thing. You'll see the chains recover and look a little different than they do today.”

“As the decline in the overall store-based video rental industry continues, that overcapacity will mean thousands of independent video stores will have to close,” chairman-CEO John Antioco told analysts in August. “Our goal is to position Blockbuster to be the biggest beneficiary of this transition.”

Hope and HD

Despite threats from the chains and changing models, independent retailers Adrian Hickman, of Philadelphia-based TLA Video, and Ted Engen, president of the Video Buyers Group, take an optimistic view.

Most of the rentailers left in the market are the savvy entrepreneurs who have ridden through tough times before and made it, they said.

“[Indies] aren't going to go away,” Engen said. “There's enough money, interest and fun left at least for some time to come to keep folks in business.

The rental market will be a training ground for the next-generation format, he noted.

With high software costs and slow hardware penetration, rental stores of all shapes will help kick off consumer awareness of high-definition discs, just like they did for standard-definition DVD, he said. “Then, it will get to a point where the mass merchants take over, just like with DVD,” Engen said.

Todd Zaganiacz, president of the National Entertainment Buyers Group, thinks backers for both formats are leaving money on the table if they don't address ways to keep the product accessible to the rental market for at least the first few years.

The VSDA's Andersen said the higher price point on high-def discs and slower adoption may actually give rentailers more of an advantage this time around than on DVD.

“HD is going to be an important factor in rental,” he said. “Equally important for the future of the rental business, it will be launched at premium prices.”

Additional reporting by Jessica Wolf

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