Painting the town Red

Having peaked at a value of nearly $25bn in 2004, the US home-video market has lately been in a worrying state of decline. So the emergence of a fast-growing new DVD retail player should be good news for the Hollywood studios that for the past five or so years have reaped the massive benefits of the DVD boom.

The US studios, though, have so far been divided on the rise of Redbox, leader in the kiosk rental sector of the US DVD market. The sector currently accounts for around 19% of all DVD rentals but is on track, according to one recent study, to account for 30% in 2010.

Eight-year-old Redbox, originally owned by McDonald’s but now part of Coinstar Inc, operates automated DVD rental kiosks in more than 17,000 US locations, including convenience stores and some McDonald’s and Walmart outlets. Each kiosk holds around 700 discs - up to 200 of them new releases - that can be rented by shoppers for just $1 a night.

The company has doubled its revenue for each of the past six years and is projecting revenue of more than $750m for 2009.

By shrinking its physical footprint, Redbox has “created efficiencies in the marketplace that have delivered better value to the customer”, said president Mitch Lowe in a recent TV interview. “We still pay the studios exactly the same as [leading traditional video chain] Blockbuster and other competitors [do].” The company has doubled its revenue for each of the past six years and is projecting revenue of more than $750m for 2009.

And over the past month, Illinois-based Redbox has been busy making friends and foes in Hollywood.
It has signed multi-year direct distribution deals with Sony, Lionsgate and Paramount that will allow it to offer those companies’ titles in kiosks as soon as the titles are released on disc. The deals could be worth a total of more than $1bn to the three studios.

At the same time, Redbox has filed federal lawsuits against Twentieth Century Fox and Warner Home Video and has been given the go-ahead to pursue an antitrust suit against Universal Studios Home Entertainment. The suits are a response to the studios’ moves to keep new titles out of Redbox kiosks for 28-45 days after DVD release.

Redbox’s Hollywood partners see low-price kiosk rental as a new DVD opportunity. “We believe the Redbox model will ultimately expand the business by increasing the number of impulse rentals,” said Lionsgate president Steve Beeks in announcing his company’s deal.

Other studios, however, fear the Redbox model will hurt both the traditional rental business and the DVD sell-through business that offers studios the biggest profit margins (Redbox kiosks also offer post-rental DVDs for sale, though that will be blocked under the new agreements with Sony, Lionsgate and Paramount). And that means it could threaten the flow of revenue the studios have come to expect from their DVD cash cow.

That flow is already slowing. According to figures from industry trade body the Digital Entertainment Group, total rental and sell-through spending in the US was down 5.5% last year to $22.4bn. And for the first half of 2009, while rental revenue was up 8.3%, sell-through was down 13.5%, making for a 3.9% overall decline to $9.7bn.

The decline could be halted in the medium term by growth in the sales and rental of high-definition Blu-ray video discs. Establishing Blu-ray, says Tom Adams, principal analyst at Adams Media Research, “is the most important thing going on for the studios right now”. The format, Adams suggests, is well positioned to revive consumer interest in home entertainment, which has slowed in the recession.

“Establishing Blu-ray is the most important thing going on for the studios right now.”

Tom Adams, principal analyst, Adams Media Research

Eventually, internet video on demand could become a major new force in home entertainment, rivalling the expected dominance of Blu-ray. VoD, argues SNL Kagan analyst Wade Holden, “is where this market is going. It is what’s going to reshape the economics of Hollywood.” Until those new revenue streams begin to flow, however, the Hollywood studios are likely to remain fiercely protective of the traditional DVD market, viewing model-changing upstarts such as Redbox with caution.