Video Stores Diversify As Rental Biz Dips

The video rental model is losing steam and revenue, and the major companies are showing it in their stock.

Consumer rental spending was still strong last year at more than $8 billion; however, that total marked the third year in a row that rental spending had decreased, according to Adams Media Research.

The big rental chains have also undergone major sea changes. Top-ranked Blockbuster, which operates more than 9,100 stores worldwide, introduced its "No Late Fees" program at the start of the year, thus eliminating a huge source of revenue.

Also, Hollywood Entertainment and Movie Gallery merged operations to become a 4,800-store joint chain.

Add to these developments flourishing online rental competition, increasingly lower sell-through prices and a slate of new releases of films that did poorly at the box office.

All of these factors have led to troubling financial reports from Blockbuster and Hollywood/Movie Gallery. Blockbuster shares are down about 33% from this time last year, and Movie Gallery shares are off about 54%.

Both have also reported continued quarterly decreases in same-store revenue. Movie Gallery, for example, expects its third-quarter same-store revenue to fall by 8%-10% compared with last year.

Meanwhile, online rental outfit Netflix is reporting increased revenue and a subscriber base of 3.2 million.

The challenges have spurred a number of changes at the big rental outlets as they try to stay afloat.

On the brick-and-mortar side, diversification is key while the market waits for stronger titles.

Blockbuster spokesman Randy Hargrove says the chain is trying to offset the decrease of in-store rentals with new revenue streams. "Our mission is to transform Blockbuster from a store you go to to rent a movie to a brand you go to to rent, buy or trade a movie or a game in-store or online," he says.

To achieve the first goal, the chain introduced its "No Late Fees" program and the Blockbuster Movie Pass, a store-based subscription rental service. In support of the second goal, it launched Blockbuster Online and a game "store in stores."

Movie Gallery is diversifying by experimenting with DVD vending machines to help extend store hours and increasing its focus on games.

"It's been the weakest box office in more than 20 years, so it's no surprise that it's a challenging time," says Thomas Johnson, senior VP of corporate finance/business development for Movie Gallery.

Both chains are also expanding sales of previously viewed DVDs to more directly compete with the low-priced DVD sell-through business.

Previously viewed movies "offer a tremendous value for our customers and provide an attractive option that traditional retailers can't provide," Hargrove says.

Even Netflix, which appears to be leaving the brick-and-mortars in the dust—its stock is up 71% in the past year—is forging new strategies.

Ted Sarandos, chief content officer of Netflix, says his company has a "laser focus on the consumer. We've stepped up to one-day delivery for most of the country and continue to invest in improvements to our infrastructure, movie availability and how fast we can process returns."

The company is also exploring electronic delivery of movies and has started selling previously viewed DVDs, services that complement regular rentals, Sarandos says.

Even though Blockbuster has its own online rental service—which had 1 million subscribers less than a year after it launched—Sarandos predicts it is too little, too late for the major chains' brick-and-mortar-centered financial outlook.

"The proposition of online DVD rental is so much better that there will be a shift in the business strong enough to start leading to the closure of brick-and-mortar stores," he says.

Business is expected to pick up starting in the fourth quarter, and the introduction of next-generation DVDs early next year will be a big opportunity.

"The good news is that the titles that are coming are showing some nice increases in box-office yield," Johnson says. "The high-definition product will have high retail price points, so rental will be a much better value proposition."

Others add that increasing gas prices may further spike rental business, as consumers seek out more home-based entertainment.

"Home video is a way to hunker down," says Video Software Dealers Assn. president Bo Andersen, who sees the industry gaining strength moving forward. "For sell-through to grow and rental to stay flat, consumers are spending more dollars on home video, and that means both sides are working well." ••••