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VHS: A Risky Buy

22 Feb, 2002 By: Joan Villa

What a difference a year makes for DVD versus VHS purchasing. As DVD gobbles up more and more new-release rental dollars, full-priced VHS titles are fast becoming a high-risk investment for retailers who say they'll trim future orders to keep VHS copies in line with dwindling profits.

Some retailers claim many rental-priced VHS titles "lose their legs" three weeks after release and others have yet to turn a profit after two months — traditionally the most active period in a title's rental life. Now, buyers who were once uncertain how many DVD copies to add to their new release shelves are struggling to hit the magic number of rental-priced VHS tapes.

"It's educated guesses each and every month," said Michael Richards, COO of nine-store Massive Video in the Boston area. "We track revenues title by title, VHS versus DVD, on a monthly basis and see if we're too heavy on the VHS side or too light on the DVD side, and then make adjustments as we go."

To manage risk on full-priced VHS, Richards has signed up with revenue-sharing distributor Rentrak for output agreements with MGM Home Entertainment and Universal Studios Home Video that require minimum purchases of all titles they release. In exchange, he pays little or no upfront costs and keeps 55 percent to 58 percent of those titles' rental revenue.

Todd Zaganiacz, owner of Video Zone in South Deerfield, Mass., and president of 42-store New England Buying Group, says a full fifth of his members have also recently turned to revenue-sharing to reduce VHS risk. While DVD represented 39.4 percent of Zaganiacz's rental business in January, when he tracked the month's top rental titles, The Fast and the Furious, Rat Race and American Pie 2, he discovered that DVD revenues on the latest releases topped 50 percent.

"We're starting to see a trend where title-by-title we're doing more DVD business than VHS," he said. For Zaganiacz that means traditional buying models no longer apply, and many studios' copy-depth programs — intended to lower per-unit costs by requiring higher volume purchases — are not keeping up with the times.

"VHS at $49 to $51 per unit a few years ago was great; it's absurd now," he said. "If you look at average VHS turns, they have dropped. The life of a title is now two to three weeks and it's dead."

Chuck Grachan, owner of 22-store J.C. Flicks in Joliet, Ill., monitored rental-priced VHS titles in late November and early December — including Planet of the Apes, The Score and Moulin Rouge — and found that many have yet to turn a profit. Now he's cutting back on full-priced VHS purchases and using revenue-sharing to reduce VHS risk, he says.

"Our DVD rental revenue is about 26 percent right now but I'm buying one-for-one, and I didn't think that would happen until about October," he said. "At this stage for VHS it's managing risk. No longer can you make $80 a copy."

Eric Smith, owner of 11-store Video King in St. Cloud, Fla., is also purchasing more DVD to adjust for the fact that the format is 35 percent to 40 percent of rental revenues.

"We're probably buying about 1.5-to-1 [VHS to DVD]," he said. "Through January titles, we were 2 to 1 and we're tightening the gap right now."

Retailers interviewed for this story were happy to see the recent spike in VHS sellthrough movies released in the fourth and first quarters by Warner Home Video and other studios, which helped equalize VHS and DVD pricing and simplified purchasing decisions. Retailers also welcome "flat" pricing from suppliers such as Artisan Home Entertainment, MGM and most recently New Line Home Entertainment, which set the March 26 VHS release Life as a House at $35.

But many retailers, large and small, are nudging their customers toward the highly profitable DVD format. Some purchase more copies to give the discs higher visibility, while others aggressively offer incentives, as Blockbuster did last Thanksgiving by giving away DVD players with the purchase of a year-long DVD rental card. Blockbuster is now actively promoting previously viewed DVD sales, which represent a significant and growing portion of the chain's revenues, according to CEO John Antioco. And Movie Gallery, the nation's No. 3 rental chain, has offered free rentals and a 40 percent discount on select DVD movies for purchasing a DVD player from its online store.

"It's to my advantage as a retailer to push my customers to DVD," said Bob Webb of five-store Video Revue in Decatur, Ill., who is cutting VHS rental-priced purchases by 20 percent. "If they consistently see more copies of DVD sitting on the shelf, then they're going to have more motivation to go out and buy a DVD player."

Webb said an analysis of VHS titles released since mid-November showed that he's spending 75 percent of revenues on new VHS releases, leaving 25 percent gross profit compared to 50 percent for DVD. "I can't keep that up," he concluded, comparing his return to Blockbuster's reported gross profit of 60 percent. "You can't run a video store on 25 percent gross profit."

At 10-store Bradley Video in Petaluma, Calif., VP Joe Kaminski said DVD represents about 40 percent of revenues, but he typically allocates a higher percentage for DVD purchases and will spend even more for discs when studios price VHS titles for rental.

"March is a big ‘program' month and the goals do not reflect changes in the business," he noted. As a result, he's ignoring some copy-depth programs entirely or making minimum purchases — a trend he expects will continue throughout the year.

Artisan's president of sales and marketing, Jeff Fink, has seen retailers take a variety of approaches to DVD growth, including eliminating VHS. However, he cautions that cutting VHS too quickly will give more business to mass merchants, who still find the category "very viable."

"DVD is starting to take over VHS space, but there are still viable SKUs of VHS product," he said, noting that the fitness and children's categories are still strong VHS sellers. "We don't see a mass exodus from the VHS business."

In the online world at ColumbiaHouse.com, where shelf space is not an issue, company president Bill Ostroff has also found that while DVD growth has outpaced the older format, there is still a healthy life ahead for VHS.

"One of the things we're finding is so many stores are converting from VHS to DVD, that the shrinking shelf space for VHS may give our VHS business a little more of a tailwind than we had anticipated," he said.

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