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THE TOP 100: Video Specialty Stores On the Upswing

30 Apr, 2002 By: Stephanie Prange

Annual Research bonanza, the Top 100. Two parts of this unique research series will appear every day this week in this space. Today we continue the series with a look at the Top 10 specialty chains and the Top 10 music and consumer electronics stores. To view supporting charts and tables, see your copy of Video Store Magazine!

While 2000 was a year of bankruptcy for some in the video specialty arena and consolidation of power for the big chains, 2001 will likely be remembered as a transitional period during which the segment turned the corner and started to grow again.

What happened?

First of all, DVD rejuvenated the business with its level-playing-field sellthrough price for rentailers and the excitement it engendered in consumers. With the growth of sellthrough pricing on DVD and broad lower pricing on VHS (led by MGM Home Entertainment), direct revenue-sharing deals between the studios and the big rental chains didn't provide the advantage against independents that they did in the past.

“[The indies] could get the [DVD] product to stock their rental departments cheaply compared to VHS,” noted Tom Adams, president of Carmel Valley-based Adams Media Research. Thus, direct deals became less important to the big chains.

“So much of our business is shifting to DVD [that] VHS revenue-sharing agreements in the same terms as in the past with each and every studio no longer makes sense,” said Blockbuster Inc. chairman and CEO John Antioco in a call with analysts last year after dropping the chain's deal with Buena Vista Home Entertainment. He added that Blockbuster basically came out even, whether taking advantage of direct studio revenue-sharing deals or the greater margins on sellthrough-priced DVD.

Second, the video-on-demand, dot-com craze had ended. Enron's deal with Blockbuster for VOD was history, and, while two sets of movie studios announced plans for VOD, its threat seemed to wane and video specialty chains were once again en vogue. Stocks for the big three -- Blockbuster Inc., Hollywood Entertainment Corp. and Movie Gallery -- soared.

“The public chains went through what has been a traditional and cyclical renewal of Wall Street's love affair with them,” Adams said. “Wall Street woke up to the fact that the technology threat is not as imminent.

“Meanwhile, video rental is a nice cash flow business,” he said.

Blockbuster enjoyed the higher rental margin on DVD, resulting in a turnaround in net income. Though Antioco told Video Store Magazine the Wal-Marts and Targets of the business cannibalized rental with their move into DVD, high margins on sellthrough-priced discs made up for the rental revenue loss.

“Rental revenue was adversely affected, but margin improvement helped to offset that,” he said.

Hollywood Entertainment in 2001 shook off the dot-com headache of 2000 brought on by its nearly $100 million investment in 1998 in now-defunct Reel.com and the resulting losses. Big fourth-quarter 2001 gains put the No. 2 chain on a path for growth again. After a year-and-a-half moratorium on new store openings, the chain is now looking to expand and in 2002 is making up ground on DVD.

The industry's perennial sleeping giant, Movie Gallery, continued its quiet reign as the No. 3 rental chain (No. 4 overall), although it made a high-profile acquisition by picking up bankrupt Video Update's more than 300 outlets late in the year. The Video Update deal also marked the chain's first international foray -- into Canada.

Traditionally satisfied plying its trade in the rural markets not fully penetrated by its two larger competitors, Movie Gallery nevertheless seemed to flirt with a higher profile.“As we grow, we recognize the benefits of promoting our brand,” CEO Joe Malugen told Video Store Magazine. To that end, the chain launched Blockbuster-like promotions such as its extended-viewing program. But Malugen still talks small town: “I don't think you're going to see a lot of national ads,” he said, noting the chain would stress “neighborhood marketing.”

With its focus on rural customers, Movie Gallery was slower to transition to DVD, Malugen said. “DVD went from about 10 percent of our rental business to 20 percent by year-end [2001],” he said. “I think our more rural nature means that our customers are a little slower to adopt DVD. I expect by the end of the year DVD will be upwards of 35 percent of the business.”

Malugen still has faith in direct revenue-sharing deals with the studios -- at the right price. “It makes us more of a partner with the studios, and I think that's a good thing for everybody,” he said. “I expect we will work out rev-share with most of the studios.”

Family Video, the top indie on the video specialty list, attributes its success to good employees, good locations, good programs and a long history in the business, president Keith Hoogland told Video Store Magazine. The chain, which now spreads across Michigan, Wisconsin, Ohio, Indiana, Illinois, Iowa and Missouri, has been around since 1977. “We've been in it the longest of anyone that's still here,” Hoogland said.

Family Video doesn't practice revenue sharing, he said, because it's not profitable, and about six months ago lobbied the studios to lower prices on VHS cassettes. “They did the right thing,” Hoogland said, noting new lower cassette pricing programs from the studios.

Like his indie brethren, Hoogland said, “we love the price on DVD [for its greater margins].”

The price drops on both DVD and VHS helped Family Video score same-store sales jumps in the double digits last year.

Hoogland said the indies are definitely benefiting from that low DVD price, but that the growth of the big chains is still a threat. Family Video's hedge on the vagaries of the video business is real estate; the chain owns its locations. “We could have had 750 stores if we hadn't invested in real estate,” he said.

Suncoast Motion Picture Co., now part of the Best Buy family, ended the year at No. 3, proving once again rental isn't everything.

While 2001 was a good year for the industry, 2002 may prove even better. “This is the payoff year,” Adams said.

“I think 2002's going to be good,” Movie Gallery's Malugen agreed.

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