The
Hollywood Economist
The numbers behind the industry.
In
1998, at the dawn of the age of the DVD, Blockbuster made
a decision that would change the future of Hollywood. Warren
Lieberfarb, who headed the home video division of Warner
Bros., offered the Blockbuster CEO John Antioco a deal that
would have made the DVD the same kind of rental business
as that of the VHS tape, which, at the time, provided the
studios with $10 billion in revenue. Lieberfarb proposed
that Warner Bros (which, along with Sony, was launching
the DVD) would create a rental window for DVDs during which
sell-through DVDs would not be available for new movies.
With
this window, Blockbuster, which then accounted for nearly
half of the studios' rental income from new movies, would
have the opportunity to rent out new DVD releases before
they went on sale for the general public. In return, the
studios would receive 40 percent of the rental revenues
that Blockbuster earned from DVDs, which was exactly the
same percentage they received for VHS rentals under the
revenue-sharing arrangement. In fact, it was Sumner Redstone,
whose Viacom conglomerate then owned Blockbuster, who personally
pioneered this revenue-sharing arrangement for video. Only
a few years earlier, Redstone had told Lieberfarb, “The
studios can't live without a video rental business—we [Blockbuster]
are your profit.” Yet, even though Lieberfarb was only asking
that the same deal be extended to DVD, Blockbuster, perhaps
not realizing the speed with which the digital revolution
would spread, turned him down.
Nevertheless,
Lieberfarb, determined to make the DVD a success, went to
plan B: pricing the DVD low enough to that it could be sold
to the public in direct competition to video rentals. Wal-Mart,
seizing the opportunity for an enormous traffic-builder
for its stores, began selling DVDs like hot cakes. By 2003,
the studios' were taking in three times as much money from
DVDs as they were from videos (click here
for the actual numbers). In this reversal of fortune,
Wal-Mart replaced Blockbuster as the studios' single largest
source of revenue. Other mass retailers followed suit, often
pricing newly-released movies on DVD below their own wholesale
price to draw in customers who might also buy products with
higher profit margins, such as plasma TVs. Blockbuster,
with no other products to sell, became a casualty of this
cutthroat competition for traffic. Not able to match these
low prices, its rental business was decimated.
The
other shoe dropped with the emergence of Netflix as a major
on-line competitor for what remained of the rental market.
(Blockbuster turned down the opportunity to buy Netflix
for a mere $50 million, instead entering a disastrous home
delivery deal with Enron.) Netflix signed up over 3 million
subscribers by 2005 by offering DVDs that could be kept
as long as renters liked for a monthly fee. To compete,
Blockbuster had to do away with its single biggest profit-earner:
charging late fees to customers who kept videos past the
due date. It also had to invest millions of dollars in a
copycat online plan. Meanwhile, even after many Blockbuster
store closings, the company was paying the rent on over
4000 brick and mortar locations in the United States. Initially,
opening new stores every week had provided Blockbuster with
outlets for the excess inventory of used videos from old
stores. The resulting proliferation of stores also provided
a competitive advantage when most people rented videos and
needed a nearby locations to return them. But as people
switched to buying DVDs, or getting them by mail from Netflix,
the plethora of stores proved a liability , leaving Blockbuster
hemorrhaging red ink: $1.62 billion in 2002, $978.7 million
in 2003, $1.24 billion in 2004, and still losing money in
2005, it had to renegotiate its loan covenants to avoid
being forced into bankruptcy. By 2006, the company Redstone
had bought in 1994 for $8.4 billion had a market value of
under $700 million.
Blockbuster
can “ reinvent” its store business, adding new products,
such as popcorn, candy, and video games, and clone a Netflix-like
subscription business, but it still has the albatross of
the huge monthly rent from its stores weighing it down.
Even if it could manage to slip out of these leases, it
would still have to contend with Hollywood's move to deliver
its movies into homes and iPods via video-on-demand. Offering
movies that could be downloaded directly by couch potatoes,
as I previously
pointed out , is the Holy Grail for Hollywood, since
it both cuts out middlemen like Blockbuster and leaves studios
in control over their own products.
As
far the studios are concerned, other than collecting the
money Blockbuster owes them for past movies, the video chain
has little relevance to their future. Viacom perspicuously
divorced itself from Blockbuster by spinning it off to its
shareholders, and, as one Viacom executive told me “Blockbuster
will certainly not survive and it will not be missed.” It
is another zombie in Hollywood.
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