Hollywood's Zombie The Last Days of Blockbuster Slate January 9, 2006 by Edward Jay Epstein

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.   [back to archive] if you have any comments please reply below: your email: