Blockbuster is staking its future on traditional DVD rentals in stores and online. To CFO Zine, the threat posed by VOD will be thwarted in several ways. (Blockbuster, which was spun off from Viacom Inc. last October, has not yet generated annual earnings as a company, due to write-downs, accounting changes, and other noncash adjustments.) He argues that Blockbuster receives new releases before VOD services, it has a bigger library of titles than VOD, and its DVD technology offers higher production values than VOD movies. Most important, movie studios don't think VOD is a big revenue generator. "The studios would have to hope for a fivefold increase in VOD rentals before VOD would really become a viable channel for them," says Zine.
That may be more likely than Zine predicts. According to Derek Baine, an analyst with Kagan Research, several studios have begun to make some films available on pay VOD simultaneously with home DVD rental. "They want to see what happens to their DVD sales when they move up the window for pay VOD," says Baine. If DVD sales aren't affected, the home DVD-rental business could face far more of a threat than it does at present.
Of course, DVD-rental companies could always counter this threat by getting into VOD themselves. Netflix has already pounced. The company, which just hit 2.5 million subscribers and posted earnings of $4.8 million on revenues of $144 million for 2004, announced an alliance with TiVo, the digital video recording service with 2.3 million subscribers, to create a "digital entertainment product." Although Netflix won't say much more than that, the service will reportedly allow customers to order a movie online at Netflix.com, which will then be loaded onto their TiVo sets, providing DVD-quality movies on demand. The combination of delivery channel, quality, and selection could dramatically change the business proposition for Blockbuster.
There's no guarantee Netflix will succeed, either. Licensing hurdles could be a deal-breaker. But standing still equals failure, eventually. And Netflix seems willing to put long-term survival ahead of short-term shareholder concerns: its stock was trading at $10 in early March, down precipitously from its all-time high of 38 in April 2004. Despite the hits, Netflix CFO Barry McCarthy is currently investing 1 to 2 percent of revenues into digital-downloading technologies, which, coupled with a recent subscription price cut, should lead to a loss for 2005. "But it's potentially important for our future," says McCarthy. "The only way to have a seat at the table is to test the proposition with consumers, figure out the best model, then rapidly innovate as you learn more about the consumer proposition."
McCarthy is unsure how long it will be before digital downloading and VOD become a "meaningful component of our revenue stream. It will come slower than people think." He says this is partly due to the difficulty of licensing digital content from studios loathe to mess with their precious DVD sales and rental revenue, and partly to the challenges of the technology required to download high-quality movies. Also at play is the price point for the "boxes" that would store the downloaded movies. Still, the TiVo alliance goes a long way toward painting a picture of how home movie rental may soon look.
In contrast, Zine says that Blockbuster takes a more cautious approach to new technologies, often buying smaller companies that are engaged in that technology, and "learning lessons" from them that they eventually incorporate into their own business model. For instance, two years before getting into online rentals, it bought a small online company, Film Caddy, and studied its operations. Only then did it unveil Blockbuster Online.
Blockbuster also purchased a small company specializing in movie trading before introducing trading to its stores. And it launched VOD tests in the United Kingdom and the United States before announcing during its annual conference call in March that it plans to launch its own VOD service on Blockbuster Online in 2006—although it had no details about how it would work, or what delivery mechanism would be used.
The company, which is now appearing to embrace VOD as a potential new business line, was far from enthusiastic about it just two weeks earlier when Zine said of VOD, "we don't think the economics work well right now." Instead, the CFO said, the company was focused on boosting revenue through its online and in-store subscriptions program (a replica of Netflix's program), same store rental revenue through elimination of late fees (a concept also pioneered by Netflix), its DVD trading program, and the transformation of some of its stores into "gaming" venues, which allow customers to rent video games before buying them. It appears that someone at Blockbuster got the message that VOD is a space in which, economics or not, Blockbuster must be.
Smoke and Mirrors?
In truth, nonchalance about impending technology may conceal aggressive behind-the-scenes moves. Whether that is the case with Blockbuster, or if there is simply a hesitance to embrace the next big thing, remains to be seen. Without a significant shift in the studios' distribution strategy, analysts predict, Blockbuster can continue to grow revenue by a couple of percentage points a year for the foreseeable future. Ironically, analysts said the same about Smith Corona, predicting that an established base of typewriter customers would never move to PCs, including a large overseas market. The company sold its assets for $6 million in 2000.
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