Studios in a Brave New World26 Aug, 2006 By: Thomas K. Arnold
It's tough being a home entertainment studio executive these days.
You've got to keep one eye on the existing DVD business, which isn't growing at anywhere near the clip it did when U.S. consumers were still converting from VHS.
And you've got to keep the other eye on the future. Not only is the next generation of high-definition discs finally here, but consumers also are showing a growing propensity to download movies over the Internet.
It's a balancing act, say the presidents of the major studio home entertainment divisions — a balancing act in which the stakes are the very fate of what's become a nearly $25 billion-a-year business.
“As the standard DVD business starts to stabilize, the entire industry has to look at how to take costs out of the business through supply-chain efficiencies, more-accurate forecasting and replenishment, and lowering returns until we reignite growth with high-definition,” said Ron Sanders, president of Warner Home Video.
But there's a hitch: Transitioning consumers from VHS to DVD was relatively easy. Once they saw the difference — higher quality, ease of use, smaller size — they came in droves. This time, however, the process is clouded by the fact that there are two rival, incompatible next-generation formats on the market, each vying to become the standard. Both Sony's Blu-ray Disc and Toshiba's HD DVD offer sharper picture — 1,080 lines of resolution vs. 480 for DVD — and hold three to five times as much data as standard DVDs.
HD DVD got out of the gate first, in mid-April, and has the added advantage of players as low as $499 (from Toshiba) — half the price of the entry-level Blu-ray Disc machine from Samsung.
But HD DVD enjoys the support of just three of the six major studios — Paramount, Universal and Warner — while Blu-ray, which launched in late June, has software commitments from five (all but Universal), plus minimajor Lionsgate.
The question studio executives are asking themselves, Sanders said, is “how do we ensure a successful launch when beyond all of our best wishes there are two formats?” His answer: “We have to make sure consumers understand the compelling benefits of high-definition so they are excited and want to purchase software to play on the 25 million to 28 million HDTV sets that are going to be sold by the end of the year.”
‘A Watershed Year'
That's not going to be easy, particularly in light of the problems facing standard DVD. After all, it's hard to focus on a room addition when the foundation of your existing house has a crack.
Can studio executives focus on both? They have to, executives agree. There's no other choice.
“It's really a watershed year for the home entertainment industry,” said Craig Kornblau, president of Universal Studios Home Entertainment. “While the DVD market remains strong, we need to listen to what consumers are saying and respond. And at the same time, we have to recognize that the keys to growth are the promising new delivery methods recently introduced into the marketplace.”
On the standard-DVD side, studio executives must manage their businesses as well as their expectations. After years of double-digit growth, the business abruptly flattened last year as saturation set in. The few new DVD households that did finally ditch the VCR proved not nearly as aggressive in their software buying as the earlier converts.
“The business is mature now,” said Mike Dunn, president of 20th Century Fox Home Entertainment. “There's no doubt about it: You have DVD penetration at 80%, and anyone who is going to be an active purchaser or renter is already in the market. So the business becomes product driven.”
Compounding this consumer malaise is an assortment of other challenges. The shelf-space crunch at retail continues to worsen; there are now more than 61,000 DVDs in distribution, and each month brings a net gain of about 1,000 additional titles, according to The DVD Release Report. Catalog pricing has hit rock bottom, as has the perceived value of DVD, thanks to the omnipresent $5 “dump bins” at Wal-Mart and similar deep-discounting at other mass merchants. And the emergence of viral video sites like YouTube and Veoh offers even more competition for consumer eyeballs, particularly since they're free.
What's a poor studio executive to do?
“You have to have a completely different go-to-market strategy than you did when the business was growing,” Dunn said. “Back then, you got your number in your first 12 weeks — now, it takes you a year to get your number. And you have to have a marketing strategy that manages the life cycle of a title over a full 12-month period.”
Retailers are partially responsible, executives say. For years, the big chains have deep-discounted hot new releases their first week out, selling them for less than $15, a couple of dollars below their cost, just to drive traffic into their stores. After that, they jack up the price to near list. For awhile, this led to bigger and bigger first-week sales numbers, but now those numbers are leveling off.
“It looks as though the core fan still buys early,” Dunn said. “But fans in the second layer, who buy on price, if they don't buy the first week, they wait until the title gets repriced or goes on sale again.”
And the proliferation of $5 dump bins at Wal-Mart or $7.44 discount endcaps at Target doesn't exactly boost DVD's value proposition, executives say. Consumers see last year's blockbuster on sale for little more than a block of cheese and then balk at paying significantly more for any other title.
DVD's Final Frontiers
To lift DVD sales, several studios are looking at expanding retail distribution, figuring that if DVD has become a commodity in which anywhere from 40% to 60% of sales are on impulse, the more potential sales points the better. Several studios are pushing DVDs into supermarkets, drug stores and convenience stores.
“We've cultivated Sears, we've expanded our Toys ‘R' Us relationship to Babies ‘R' Us, and we're now in Burlington Coat Factory stores,” said Buena Vista Home Entertainment's Lori MacPherson, GM of North America. “They have a pretty big infant section.”
At 20th Century Fox, “our biggest push over the past 12 months has been into Christian bookstores,” Dunn said. “We've expanded distribution by 3,000 points — we've built a market that wasn't being served.”
Fox had been toying with Christian bookstores for some time until The Passion of the Christ thrust the door wide open, Dunn said. “Now we have all of our family titles in there, such as The Sound of Music, Because of Winn-Dixie and Cheaper by the Dozen 2. And we just crossed the $100 million revenue point this year.”
Universal's Kornblau likes the vending machines at McDonald's. “It's an established fact that people want to own their favorite movies and TV shows,” he said, “so to whatever extent we can make the process of acquiring titles more convenient, it's a plus for both consumers and the industry.”
New Line Home Entertainment president Stephen Einhorn agrees. “I am a firm believer that expanding the distribution outlets for DVD will result in incremental sales,” he said. “As long as these outlets generate incremental profitability, we will continue to evaluate and/or support most of these ‘buy' points.”
Add-Ons and Touch-Ups
In addition to expanding distribution, studios are tinkering with DVD itself. Several are gearing up their direct-to-video operations, often by riding the wave of popular theatricals and producing sequels available exclusively on DVD. Among them: Universal's American Pie Presents: Band Camp and Carlito's Way: Rise to Power, both top sellers.
Studios also are striving to create more compelling bonus features, which are consistently cited by consumers as one of the chief reasons they buy DVDs. New Line, for example, created a groundbreaking DVD for Final Destination 3 that lets viewers change the course of the movie — and even save one of the doomed characters from his fate.
Enhancing the DVD experience isn't limited to new releases.
“We continue to look for opportunities to refresh our stronger catalog titles, taking advantage of new content or, in the case of early releases, remastering and providing a better overall movie-watching experience,” said New Line's Einhorn. “For the long-term health of the industry, we must effectively deliver value to the consumer that focuses on entertainment and quality as opposed to chasing downward-spiraling pricing.”
At the same time, studios are relentlessly striving to streamline their operations and work more efficiently.
“We're working to replenish better and more efficiently so that when we use retailer space it has the best yield for them,” said Benjamin Feingold, president of Sony Pictures Home Entertainment. “In terms of new-release inventory that we ship in, quantities have been coming down for the whole industry, so it becomes more of a replenishment business.”
“We're taking strategic steps to maximize each and every one of our releases,” added Kelley Avery, worldwide home entertainment president for Paramount Pictures. Marketing campaigns are increasingly targeted, she said, and the studio is working more closely than ever with retailers “to maximize opportunities and drive the most business to stores.”
Avery is a bit more optimistic than her fellow studio heads.
“We are feeling good about the year,” she said. “The first half of 2006 is showing positive signs, with DVD rental up, the sellthrough market on par with 2005, TV DVD and kidvid categories continuing to grow and a stronger box office slate. As the theatrical box office continues to improve, we expect this upward trend to carry over to the home entertainment business.”
A Look Ahead
Meanwhile, everyone's concerned about laying a proper groundwork for the future. Both the HD DVD and the Blu-ray camps are planning major marketing campaigns in the fourth quarter, in the hopes of reaping some dollars from consumers hungry for high-def content to play on their HDTVs. Based on projections that some 25 million U.S. households will have HDTVs by the end of this year, Warner Home Video predicts consumer spending on HD media by year's end will be anywhere from $290 million to $740 million.
Blu-ray expects to get a big boost when PlayStation 3 arrives in November, which Fox's Dunn predicts will give the format a decided edge over HD DVD. “I think once you see PlayStation 3 hit with all its marketing, you're going to start seeing some really big numbers on specific titles. Once you have that, you have momentum,” he said.
Studio executives also expect additional profits to come from digital downloading, which began in earnest this year when the big studios, after years of talk, finally began selling their movies over the Internet. Since April, all six of the major studios — Buena Vista, Fox, Paramount, Sony, Universal and Warner — as well as Lionsgate have begun offering download-to-own sales of feature films, concurrent with the DVD release window, through MovieLink or CinemaNow. The business shows so much promise that studio marketers have even coined a new phrase for the process: electronic sellthrough, or EST.
The market is expected to grow significantly when the download-to-burn option, which so far is only a reality at CinemaNow, becomes widespread and includes all releases, not just the catalog titles available now.
Executives see distinct roles for each future delivery system and pooh-pooh notions of cannibalization.
“These two technologies offer a unique set of features that appeal to different groups of consumers,” said Universal's Kornblau. High-definition packaged media, he said, “adds value in terms of additional material and enhanced picture and sound quality,” while EST “offers audiences unparalleled convenience — where you want it, when you want it and how you want it. Early adopters will move quickly to embrace one or both of these delivery methods. And as with all new formats, they will slowly be integrated into consumers' lifestyles, establishing that DVD, HD DVD and EST can happily coexist.”
Kornblau's theory is supported by Understanding & Solutions, which projects that consumer spending on home entertainment will hit $30 billion by 2010. Standard DVD will account for $15 billion, high-def media will generate $10 billion, and EST will bring in an additional $5 billion.
“We think they are all going to coexist,” said Warner's Sanders. “All consumer research and history shows that when you give consumers portability, convenience and ways to consumer media in multiple platforms, they tend to consume more of that media and the pie grows.”