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With New Technologies, Fast-Forward to Death of Video Rental Sector?


The long-predicted demise of the video rental business is in full swing.

Two large public video chains, Video Update Inc. of Minnesota and Torrance-based Video City, recently filed for Chapter 11 bankruptcy protection. Those moves follow the more than 100 independent video stores that industry sources estimate have gone out of business every month for two years--a trend that shows no sign of slowing.

Wall Street took the hint. In October, the top video specialty chain, Dallas-based Blockbuster Inc., saw its stock price nose dive from $15 to below $7 a share, less than half its IPO price from a year ago. The second-biggest chain, Hollywood Entertainment Corp. of Oregon, lost more than one-third of its share price in a single day in mid-October, dropping from around $7 to hover a week later around $3.50. In the wake of that decline, chain President Jeffrey Yapp resigned, with founder Mark Wattles taking operational control.

Even traditionally upbeat industry analyst Paul Kagan Associates has declared video rental is "dying." Another research firm, Alexander & Associates, said the percentage of active renters has dropped off 20% in recent weeks.

"In an era of slack sales, I think the chains have used their purchasing muscle to dominate the industry, and now even the chains aren't doing that well," said retailer John Merchant, who in the last two years has sold or closed four of his five 49'er Video stores in the Sacramento area.

"There's tremendous competition for leisure time. You've got the Internet, the influx of satellite and other alternative delivery systems, and all these things have damaged video. I don't think anyone is dominant, but take them together and that's a pretty significant bite," Merchant said.

Kagan concurs. The industry analyst estimates that consumer spending on video rentals will inch up 1% this year to $8.3 billion, remain flat in 2001 and then start to decline in 2002. By 2005, Kagan predicts, consumer rental spending will be down nearly 9%--and that includes DVD rentals.

"It's no surprise that all these new technologies are going to cut into rental," said Derek Baine, a Kagan analyst. "The deal Blockbuster has with DirecTV [in which the giant video rental chain is selling satellite systems and service] is a good one, but what they are basically saying is that video rental is going to shift toward pay-per-view and then eventually toward video-on-demand."

Artisan Home Entertainment saw the writing on the wall and reacted. The independent home video supplier during the last few years has shifted its focus from high-priced "B" movies aimed at the rental market to a wide variety of product, from children's videos to Denise Austin fitness tapes, priced low for direct sale to consumers. President Steve Beeks said 70% of Artisan's video revenue comes from the sell-through market.

Other independent suppliers that continued to rely on rental product, meanwhile, have gone out of business, or are undergoing tough financial times.

"What we're seeing now is just the culmination of a trend that's been going on for years," Beeks said. "The reality is, we are all really hooked on the drug of DVD right now, which is really all that's keeping profits up."

Ironically, the demise of the rental videocassette is being hastened by the rise of the digital videodisc. With more movies simultaneously coming out on cassette and on disc, cannibalization is starting to occur.

Most videocassette versions of new movies are priced around $100 for their initial six-month run on the rental market. DVD versions are priced below $25 right out of the gate. The majority are sold directly to consumers--who then have no need to rent.

"DVD rental is not incremental revenue," Baine said. "It's people who used to rent VHS and, for the most part, people who are eventually going to migrate to pay-per-view."

Artisan's Beeks also believes DVD rentals are a short-term fix.

"It's a short-term prospect that we are going to have to deal with in about a year or two, when the installed base of machines gets up to 30 million or 40 million and people start changing out their VHS machines for DVD," Beeks said. "When DVD becomes a viable rental business, something's going to happen."

Industry observers think that once DVD rentals start significantly eating into VHS rentals, studios will intervene, either by raising DVD prices or by closing the traditional gap, or "window," between a movie's release on video and its debut on pay-per-view.

And yet not everyone is ready to pronounce video rental dead. In contrast with the Kagan findings, analyst Tom Adams believes that the explosive popularity of DVD will drive both video sales and rentals to record heights. He predicts total consumer rental spending, on VHS and DVD, will grow to $13.6 billion by 2005, nearly twice the Kagan estimate.

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