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Video Renter Fights Store by Store

SPECIAL TO THE TIMES

For more than five years, the Blockbuster Video store at the corner of Western Avenue and Capitol Drive reigned over the neighborhood bordering Rancho Palos Verdes and San Pedro. That changed several months ago when a sprawling Hollywood Video store opened across the intersection. Business at the older store suffered, despite a two-for-one rental promotion timed to coincide with the opening.

“It affected us quite a bit in the beginning,” says a Blockbuster manager who requested anonymity. “I was kind of shocked it was so close. Maybe a few blocks away, but kitty-corner?”

Although the manager says store traffic has picked up recently--Blockbuster declined to provide revenue figures--the episode illustrates the pressure that increased competition has brought on the troubled chain. Where Blockbuster once dominated as the sole national chain of video rental superstores, now several others are nipping at its heels--and none more aggressively than Hollywood Entertainment.

While Blockbuster continues to struggle with internal problems, the nation’s No. 2 chain has been making waves as Chief Executive Mark Wattles continues his rapid expansion. Averaging one new store a day, Hollywood--one of the only publicly held chains to post better sales during an industrywide rental slump earlier this year--has earned a reputation for its aggressive marketing, glitzy stores and hit-rich inventory.

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Already more than 700 stores strong, the chain based in Beaverton, Ore., recently entered the L.A. market, opening 18 stores in neighborhoods ranging from Pasadena to Hawthorne, with at least 100 stores planned for the region. As in other markets, many of the L.A. area stores are located close to--if not across the street from--Blockbuster stores. Hollywood’s leader is known for his willingness to fight the competition head on.

The 37-year-old Wattles, who opened his first 500-square-foot video store at age 25, says he was inspired to develop his own national chain after watching Blockbuster wreak havoc on local retailers in the Portland, Ore., area.

“I could sit back and watch Blockbuster roll into town or I could say, ‘I could do better,’ ” Wattles says. “And I wasn’t interested in sitting back.”

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Instead, he spent several years refining his concept locally, then began rolling out nationally in 1993. His goal: To open stores in best locations available, regardless of how close and big the competition was.

“Everybody thought they were crazy when they first started doing that, but it works,” says Derek Baine, analyst for Paul Kagan & Associates, a media research firm in Carmel. “What they’re doing is choosing real estate in prime locations, just like Blockbuster.”

Wattles says location is the foremost consideration when developing a new store. “We do our transaction based on the best site, not the competition,” he says.

Besides, Wattles points out, if Hollywood were to avoid Blockbuster, that would rule out a lot of territory, because the mega-chain has nearly 4,000 video stores nationwide.

“Our model has to assume we’re opening near a Blockbuster,” he says.

As it turns out, 80% of all Hollywood stores are located within two miles of at least one Blockbuster. That proximity, along with similar heat from the expanding Video Update chain of Minnesota, has taken its toll on Blockbuster at a time when annual industry revenue is flat at best.

“Domestic revenue is not growing,” Kagan’s Baine says. “So what’s happening is these stores are fighting for market share.”

“The question is, how profitably can several video stores operate in close proximity?” asks Curt Alexander, analyst with Media Group Research of Providence, R.I. “It doesn’t matter how big the town is--say it’s 10,000--if it’s any kind of business at all, when the new store comes in you’re instantly going to lose 15% to 20% of your business.”

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At Blockbuster, where former Taco Bell executive John Antioco has yet to speak publicly as the new chief executive, a spokesman downplays the rivalry with Hollywood Video.

“Competition happens locally,” says Jonathan Baskin, senior vice president of corporate relations. “Customers don’t care who’s No. 1 or 2.”

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However, one of the many practices that got Blockbuster into trouble, Baine says, was trying to offset increased competition by buying too many copies of high-demand “A” titles, which typically cost $60 to $70 per unit wholesale.

“They finally said in the first part of this year that they were going to cut back on their buys,” Baine says. “And part of the reason was buying 100 copies of everything cuts into margins.”

Hollywood offsets this problem in part by using the Rentrak pay-per-transaction service to boost its inventory on selected hit titles. For a minimal outlay of $8 a copy upfront, the chain can beef up its inventory of the most in-demand titles, then pay Rentrak a hefty portion of the rental profits in return. However, Wattles says the chain uses the service sparingly.

“Last year, we did only five revenue-sharing titles of the 500 some titles we acquired during the whole year,” he says.

Analysts say Hollywood’s biggest advantage has been its steady focus on the rental side of the business--in contrast to its rival, which has been criticized for diversifying its product mix under ousted Chief Executive Bill Fields.

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“Blockbuster’s tried to reposition itself several times in the last year and a half, and that’s bound to confuse the customer,” says analyst Scott Barry of Raymond James & Associates of St. Petersburg, Fla. “Hollywood’s remained true to its vision.”

Wattles’ philosophy is to spend big opening each store, then reap the riches as the store matures, a practice seemingly borne out by the fact that Hollywood stores generate the highest average revenue in the industry, according to Kagan; Blockbuster is a close second.

Hollywood, which tends to have more colorful stores than the cleaner, cookie-cutter look favored by Blockbuster, spends an average of $500,000 to open a new store, according to Wattles. Analysts say Blockbuster spends $400,000 on each new store.

Hollywood may also benefit from its rental-rate policies, which are more liberal on older titles. Although the chain is experimenting with higher rates, it currently allows customers to keep older catalog titles for up to five days for $1.50.

Locally, Blockbuster charges $3.52 for all titles, but rents those in release for one to two months for two evenings at that price.

Can Hollywood sustain this type of rapid growth? The chain, which recently secured a new credit line of $300 million, weathered tough times a few years ago, but analysts believe it’s less vulnerable now.

“I think the next problem that may ultimately befall them is all these new stores they’re building may under-perform,” analyst Alexander of Media Group says. “That happened before--two years ago--but . . . the chain’s now better run.”

After seeing its stock price plummet in late 1995, Wattles reorganized the chain into four zones and recruited industry veterans to help orchestrate its expansion.

The result: Sales more than doubled between 1995 and 1996, to $302 million last year. More important, earnings also more than doubled, to $20.6 million last year, or 59 cents a share.

Hollywood’s stock, which sold for under $10 on Nasdaq in early 1996, zoomed to $25.88 by this spring--though it has since fallen back to $16.88 as of Tuesday. That, despite the company’s report that second-quarter earnings rose 67% from a year ago, to 15 cents a share.

Meanwhile, Class A shares of Blockbuster’s parent, Viacom Inc., have slumped from $52 in mid-1995 to $30.19 currently on the American Stock Exchange, as Viacom has struggled with a number of its businesses.

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In the video business, Blockbuster remains the industry leader by a wide margin, commanding about a quarter of the domestic market, with Hollywood controlling about 5%.

And nobody expects Blockbuster to stay down for long.

“In my opinion, Blockbuster will be back by the end of the year,” Wattles says. “I think their problems have been overblown.”

For his part, Wattles expects to have 1,000 Hollywood stores up and running by year-end. “Our goal is to continue opening as many new quality sites as available in the U.S. What that number is, I couldn’t say--hopefully at least 2,000.”

That’s still well below Blockbuster’s current domestic video store count and Wattles has no illusions about reaching the top video retail spot any time soon.

“Blockbuster’s No. 1, and they’ll probably always be No. 1,” he says. “But we don’t intend slowing down.”


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