Sale of DVDs Is Challenging Movie Rental Business

17 Apr, 2001

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As the DVD is quickly gaining on the venerable VHS videocassette as the videophile's format of choice, the studios are taking advantage of the technology shift to rethink the business model movie rentals that has dominated the home video market for two decades. The DVD business is shaping up as a seller's, not a renter's, market.

So far, in the four years DVDs have been on the market, sales have outpaced rentals by more than four to one in dollar terms. And pricing is far from uniform. "The studios have different views of the market, so they are setting different suggested retail prices, and the stores are discounting those prices to different degrees," said Tom Adams, whose Adams Media Research tracks the home-video industry.

In part, the studios are responding to a stagnating VHS rental market, in which revenue actually declined by 5% last year, to $16.9 million. But a strategic schism is also developing with the rift most apparent between Warner Home Video, which is owned by AOL Time Warner, and Blockbuster, which like Paramount Pictures is owned by Viacom.

As a major cable company, AOL Time Warner plans to eventually offer video-on-demand movie service, giving consumers all the benefits of renting a movie, without having to visit a Blockbuster or other video store. The first weapon in this battle is the DVD.

In the case of the DVD short for digital videodisc Blockbuster and the studios do not share rental revenue, as has been the practice with VHS tapes. Instead, the studios simply sell the DVD's outright to video stores for about $16 each on average and the video stores can then rent them or sell them.

At the same time, in an even bigger shift of video economics, many of the studios are selling their DVDs to retailers like Wal-Mart and Target for about the same price they charge rental chains like Blockbuster. The DVD shift portends the film industry's becoming much less financially vested in the movie rental business, and growing less dependent on chains likes Blockbuster.

"Blockbuster is an endangered species," said Warren Lieberfarb, president of Warner Home Video.

Blockbuster, of course, is not ready to concede.

Lieberfarb is "out to lunch," in the view of Blockbuster's chairman, John Antioco. "DVD sales will never replace rentals," Antioco said. "If Warner lowers the price, that will be the best news I have heard in a long time. We can lower our price somewhat to the renter and our margins would improve."

Over the last year, in fact, Blockbuster has done just fine, gaining market share at the expense of rival video store chains like Hollywood Video and Video UpDate. And like the mass-market retailers, Blockbuster has benefited from the sales surge in DVDs.

Analysts estimate that cash flow at Blockbuster in 2001 will rise 15%, to $600 million, and Mr. Antioco has no argument with the sanguine projections. "Our transactions are up, and we are going to keep growing," Antioco said.

He also points out that DVD rental transactions are growing faster than DVD unit sales. That is true, although while rental spending for DVDs rose nearly 600% last year, to $747 million, the business remained far smaller than DVD sales, at $3.4 billion.

Whether renting them or selling them, distributing movies on disc and tape is likely to continue to be a big part of the film studios' business. The home video market represents an average of 40% of the revenue for a major movie release. And in years when a film studio does poorly at the box office, receipts from the continuing video sales and rentals of older films can help cushion a revenue decline. But it is clear that with this new generation of video technology, the studios are devising distinct strategies.

Some of the differences can be seen in the prices. A recent release like Warner's The Green Mile DVD has a suggested retail price of $24.99, for example, while Dreamworks' American Beauty disc has a suggested price of $26.99. Meanwhile, Paramount has listed Double Jeopardy, which underperformed both those films at the box office, at $29.99. Paramount, as Blockbuster's corporate sibling, is much less intent on disrupting the current rental paradigm. (Retailers often sell the discs below the suggested price.)

It was in February 1997 that the first DVD players went on the market. And since then, some 15 million American households have purchased the machines. That is still far behind the estimated 95 million, or 94%, of households with at least one VCR. But DVD players are quickly gaining ground, and by 2006 nearly two-thirds of households will have them, according to forecasts by Adams Media Research.

Liberfarb predicted that as more people buy DVD players, disc prices will continue to fall, further enticing consumers to buy rather than rent.

"We are trying to drive this to be a mass distributed, high-volume impulse purchase, like a trade softback or paperback book," Lieberfarb said. "Ultimately, DVDs will be distributed as ubiquitously as paperback books."

Sony's studios Columbia Pictures and Tri-Star Pictures have a pricing policy similar to Warner's. "Where Warner and Columbia share a point of view is that it is a mass- market product and for that to be, whether you are in blue jeans or khakis, you have to price within a range to make it a no brainer to buy," said Ben Feingold, president of the Columbia Tri-Star Motion Picture Group.

And yet Blockbuster's sibling, Paramount, is not the only film company that declines to follow Warner's low-price policy.

"I don't think it's good for the market to underprice," said Bob Chapek, president of Buena Vista Home Entertainment, the video distribution arm of the Walt Disney Company. Even at the current growth rate, he said, the DVD player is still a device of enthusiasts and early adopters. Like several other industry executives, Chapek said he believed that most of today's DVD customers were willing to pay higher prices for DVDs to enjoy their superior picture and sound quality.

Craig Kornblau, president of Universal Studios Home Video, said that studios that offer lower prices "are dumping their catalogs at ridiculous prices." While he acknowledged that prices would eventually fall, as DVD players become commonplace, he asked, "Why take it there now?"

And Patricia Wyatt, president of Fox Consumer Products, which distributes home videos for the News Corporation's 20th Century Fox, predicted that there would always be a role for movie rentals, because they give consumers a low-priced way to see a film without the commitment of making a purchase.

But all the studios would benefit in the longer term if more renters become buyers. According to Adams Media Research, consumers spent $10.3 billion last year to rent videocassettes and DVDs. Of that total, the studios kept only about 26%, or $2.7 billion. But of the $10.8 billion that consumers paid to buy tapes and discs, the studios pocketed a full 75% or $8.2 billion.

But an industry consensus on marketing DVDs has proved far harder to come by than one for VHS videocassettes. The VHS tapes, after all, were introduced before most major film studios were part of giant media conglomerates with complex networks of entangling alliances.

Their corporate masters aside, the studios do have some common interests and a commmon gatekeeper. Blockbuster currently dominates the VHS rental business, with a 30 share of the market. And the studios have the same basic arrangement, under which Blockbuster pays an upfront fee of about $8 a cassette, then gives the studios roughly 40% of the rental revenue and keeps the balance.

Retail sales have always been part the videocassette business, too, providing much fatter profit margins for the studios, which keep an average of 75% of the price of each VHS version of a movie sold. But rentals still represent the larger part of the VHS market.

Against this legacy, one of the motives for the studios to make DVDs primarily a retail-sales business is to reduce their dependence on Blockbuster, said Adams, the research analyst.

And among the studio owners, AOL Time Warner in particular has little motive to perpetuate the rental business.

For one thing, in the mid-'90s, well before the merger with AOL, Time Warner was involved in developing the digital video disc with Toshiba. The company holds 11 patents on the DVD format, which means that AOL Time Warner receives royalties for each disc and DVD player sold. Lieberfarb, of Warner Home Video, declined to reveal the size of the royalties, but he said that the money was not enough to dictate Warner's DVD strategy.

Of more strategic importance may be AOL Time Warner's plan to eventually offer video on demand to cable customers around the country. With 12.7 million subscribers, AOL Time Warner is the nation's second-largest cable operator, just behind AT&T. Though still at least several years away, widespread video on demand offering libraries of movies that would start whenever the viewer dictated, and could be paused and rewound would compete directly for Blockbuster's rental market.

And yet, Lieberfarb said, video on demand would not necessarily compete with the DVD sales business. "Consumers will buy the ones they really want for the family," he said, "and there will still be room for a healthy video-on-demand business in films consumers only only want to see once. Discs are the stuff you really, really want or that the kids or wife want to watch. I think we will have two different businesses. A packaged media business with discs. And the video-on-demand rental business.

"Both methods offer a more convenient and better quality experience than renting analog VHS tape," Lieberfarb said. "Blockbuster is finished."

But Blockbuster's Antioco points out that video on demand is still in only a few hundred thousand American homes. Far more common today is pay per view, which offers films on several channels at staggered starting times. That gives viewers who pay to see the movie much more flexibility about when to watch. But pay per view is not a true alternative to a rental video or to future video on demand because once the film begins, consumers cannot stop and start it at will.

But Blockbuster is clearly aware that rival technologies represent a threat to its rental business. It now sells dishes and receivers for DirecTV, the satellite service that offers a large number of movie channels.

This summer DirecTV plans to rebrand its pay-per-view business to include the Blockbuster name. Adams considers this a smart strategy, because the DirecTV pact gives Blockbuster a way to extend its rental brand into the digital, interactive world.

As for Warner Home Video and its emphasis on DVD sales, Lieberfarb says he continues to bet that "America is a nation of shoppers."

(Adapted from The New York Times)

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