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What Happens If Retailers Subscribe?

9 Jul, 2003 By: Stephanie Prange

The growing subscription rental model could both pose problems — notably the loss of late fee revenue — and create advantages for retailers, industry observers say.

It's certainly a trend. As the online DVD subscription rental service Netflix has gained popularity, brick-and-mortar retailers have taken notice. Not only have some — notably Blockbuster and Wal-Mart — entered the online DVD rental business, the subscription model has moved in-store.

Blockbuster is testing a movie subscription model in certain markets and just rolled out the game subscription model nationwide.

Grocer Albertsons is testing a $19.95-per-month subscription model in more than 800 stores in the California; Portland, Ore.; and Seattle markets.

As the business enters the brave new world of subscriptions, retailers worry that a significant part of their sales — late fees, tagged at around 15 percent of revenue by analysts — could be threatened by a move away from the transactional model.

Indeed, Video Store Magazine market research estimates a whopping $1 billion will be spent on late fees this year. That's a big chunk of change that could severely impact retailers if the subscription model takes over.

“I think consumers really like the notion of subscription rental,” said Ted Sarandos, VP of content acquisition for Netflix, but added “it's risky” in the brick-and-mortar rental setting. Netflix, in fact, tried a store and ultimately chose to discontinue the test, he noted. “Profitability was elusive, to say the least,” he said.

“It is scary,” agreed analyst Tom Adams of Adams Media Research based in Carmel Valley, Calif. “There's an ingrained view of business being dependent on late fees.”

Many stores work on a profit margin of 10 percent to 15 percent, so threatening 15 percent of revenue in late fees with a subscription model “would be a total leap of faith for most stores,” he said.

Many retailers see late fees as an important revenue stream.

“When I look at how much rental revenue I would lose if my best renting guests converted to a subscription model,” it includes late fees, said Mick Blanken of Superhitz Moviez & Gamez in Delaware, Ohio. “I look at it as 16 percent of my rental revenue is generated after a guest returns their movies. A loss of rental revenue is a loss of rental revenue, no matter when it is paid.”

Still, others see possibilities in the subscription plan.

“I am not concerned about losing late-fee revenue with a subscription plan, because one, those customers more likely to subscribe to a plan rent a lot and are usually not too late in returning items, and two, it could be a way to keep large late-fee customers,” said Mike Frese, of Movie Tymes in Lake of the Ozarks, Mo., who noted late-fee customers often avoid coming back because they know they have late fees. “Many people say, ‘Oh well it is just a $15 movie, so who cares if I never take it back.

“I believe any effect will be minimal regarding late fees. But, on overall profitability, I really do not know,” he said.

That “unknown” factor about profitability under the subscription plan has prompted Blockbuster to test it before rolling it out nationwide. Indeed, Blockbuster's test last summer of the game subscription model at first proved “too rich,” Blockbuster CEO John Antioco noted at a recent analyst event. The chain adjusted the plan to give customers only one game at a time, rather than two.

Antioco said in late 2002 Blockbuster planned to launch the DVD Freedom Pass subscription model nationally early this year. That plan looks to be changing. According to spokesperson Karen Raskopf, Blockbuster is still testing the in-store program. Blockbuster has announced the test in six markets: New York City, Phoenix, Houston, Seattle, Salt Lake City and Hartford, Conn. Competitors say Blockbuster has expanded that test to at least 18 markets.

“We've been testing different price points in different markets,”Raskopf said. The average is $25 per month, she said, with some subscriptions in some markets priced as high as $29.99. Some markets are DVD only, some DVD and VHS, she said.

“We plan to extend the [movie] Freedom Pass, but we are not extending that nationally,” she said, noting certain markets more readily lend themselves to the model. “It's probably about 10 percent of our customers who are going to want a subscription model. We think the rest of the people will want to do pay-as-you-go.”

She agreed with common wisdom that customers don't exactly embrace late fees.

“To the extent we can give consumers something else that's going to make them go home happier, the revenue increase would offset any decrease in extended-viewing fees they pay,” she said. “Our goal is not to make money by making customers unhappy.”

As Blockbuster's go-slow approach indicates, the devil could be in the details of a subscription plan. Analyst Adams notes a “key data point” would be the average number of rental titles per customer per month.

A December 2002 Forbes article reported that key data point is five rentals per customer per month for online subscription leader Netflix, he noted. “If indeed Netflix is getting five rentals per month for $20, we're talking about over $4 per rental,” he noted. “That compares favorably with a la carte and late fees.

“The key is how much usage you get,” he said.

He also noted the move from online to in-store subscriptions won't necessarily result in the same boost to secondary titles on which Netflix has built its model.

“In the in-store model, there is the expectation of getting the hit, whereas the mail-order model is a delayed gratification model as it is,” he said.

Another danger in-store: cherrypicking. Customers who are the biggest renters might gravitate toward the subscription, while light renters won't.

“You are most likely to convert heavy renters first,” said Netflix's Sarandos. “There is a danger of turning a $50 customer into a $20 customer.”

But Adams noted Netflix has made its point about subscriptions.

“In a world in which Netflix has more than 1 million subscribers, we're probably headed toward a world where everybody may have to make it available,” he said. “Competition is so much more extreme” from all entertainment sources, many of which offer subscriptions, he said.

His advice to retailers: If you do have to go subscription, bite the bullet and “launch it with fanfare.”

Like Blockbuster, retailers could start with games, which lend themselves to the subscription model because they are time-intensive.

“I think the game thing is absolutely brilliant,” Adams said. “Everybody should at least be trying that right away.”

Additional reporting by Holly J. Wagner.

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