Rental Control

By KEVIN BRASS

Nov. 28, 1997 12 AM PT

SPECIAL TO THE TIMES

When Mitch Pool, owner of South Shore Video in Huntington Beach, sees Wherehouse and Hollywood Video “guarantee” the availability of such titles as “The English Patient” and “Dante’s Peak,” it strikes to the core of his business. He can’t compete.

“It changes the perception of the customer,” Pool said. “Customers think we always should have 60 copies of a movie on the shelf.”

Wherehouse and Hollywood are able to make the offer by flooding shelves with cassettes leased through Rentrak Corp., the fastest-growing and most controversial distributor in the business.

To some in the industry, Rentrak is a sinister force. In a recent letter to a trade magazine, one retailer equated signing a contract with Rentrak to “selling your soul to the devil.”

In essence, the Portland, Ore.-based distributor seeks to rework the basic economic structure of the $8-billion video rental industry, the single-biggest cash cow ever developed in entertainment.

Normally a store pays about $60 for a copy of a rental-priced title and then keeps all the revenue generated by renting it. Rentrak offers titles to retail stores for only $8 a copy, but the rental revenue is split among the retailer, the studio and Rentrak.

Rentrak gives stores the opportunity to stock dozens of copies of a new title for a relatively modest initial investment.

With more and more stores desperate to compete against big chains of “superstores,” Rentrak went from supplying 4,000 stores in 1995 to more than 6,400 stores in 1997, including six of the 10 biggest chains. Rapidly expanding Hollywood Entertainment, which is adding more than 250 Hollywood Video stores a year in its quest to battle Blockbuster Entertainment Group, is Rentrak’s biggest customer, accounting for 13% of Rentrak’s revenue last fiscal year.

In a major industry shift within the last few weeks, Blockbuster, the 800-pound gorilla of video store chains--long an opponent of Rentrak and critical of its business model--has been negotiating its own revenue-sharing deals with studios. Reports of Blockbuster’s move into revenue-sharing helped push Rentrak’s stock price up more than 20%, even though the 5,900-store chain still refuses to work with Rentrak.

“It adds tremendous credibility to revenue-sharing as a concept,” said Rentrak President and Chief Executive Ron Berger, the man responsible for developing and marketing Rentrak’s system.

Berger founded Rentrak in 1986, primarily pitching it as a way for small retailers to compete against Blockbuster.

“Blockbuster single-handedly exemplified the attitude that you didn’t have to carry enough copies of the hits, because a customer would go in and just rent what was in the store,” Berger said. “Those days are over. The customers can drive right past Blockbuster.”

Rentrak gives stores a chance to satisfy demand for a hit. It also inserts the studio into the rental revenue stream.

Even though home video accounts for more than 50% of their revenues, the studios have often expressed resentment toward the video-store system, which allows retailers to keep making money on movies without including the studios.

They view Rentrak as offering them both potentially greater profits and a way of shipping more copies of a title. Rentrak’s success has spawned the term “Rentrak numbers,” referring to sales figures inflated by inexpensive Rentrak cassettes saturating the market.

Studio executives “are under tremendous pressure to boost their numbers,” said Bob Alexander, president of Alexander & Associates, an industry research firm. “Disney announced it shipped 750,000 copies of ‘The Rock,’ and more than 150,000 were probably shipped through Rentrak.”

Walt Disney Co., which reportedly demands double-digit annual revenue increases from its home video division, is one of Hollywood’s biggest supporters of revenue-sharing. Last fiscal year, Disney titles such as “The Rock” accounted for 43% of Rentrak’s revenue.

Disney also owns SuperComm, a Dallas-based revenue-sharing distributor that focuses on supermarkets in the United States.

20th Century Fox Home Entertainment and Universal Studios Home Video are the other major studios distributing titles through Rentrak.

The other studios have rebuffed Rentrak. Although they decline to discuss Rentrak on the record--as did all the major studios--the opponents are dubious of Rentrak’s revenue projections, and they prefer to receive their video money upfront, removing an element of risk. They are also wary of offending traditional distributors, who still handle the vast bulk of the industry’s business.

“Right now the studios are tinkering with the [video economic] model more furiously than ever before, and I think that has contributed to the uncertainty of the overall business,” said Bill Burton, the executive director of the National Assn. of Video Distributors, which represents Rentrak’s competitors.

Some video suppliers, such as LIVE Entertainment, advertise to the retail industry that their titles are not offered through revenue-sharing, hoping to spark increased buys among anti-Rentrak retailers.

“We believe it is economically sound for retailers to own the product outright and for us to sell the product outright,” said LIVE Executive Vice President Jeffrey Fink.

Rentrak CEO Berger vows that his company will eventually sign all the studios.

In fact, Rentrak now has “output agreements” to distribute all the rental-priced titles from more than 30 labels, including Disney, Fox and Universal. (The studios distribute their sell-through titles, which are marketed directly to consumers at a lower cost per unit, separately.) Columbia TriStar Home Video, a non-Rentrak participant, is reportedly testing a revenue-sharing arrangement with Blockbuster.

“Ultimately the studios will recognize that revenue-sharing will grow the business in a way not achievable in the old system,” Berger said.

The studios will sign on because more and more retailers are using the system, said the 49-year-old Berger, who approaches the business from a retail background. After building a chain of franchised camera shops, Berger started the first national video franchise chain, National Video, which he eventually sold to focus on Rentrak.

In the early ‘90s, Rentrak signed distribution agreements with Disney and Fox, giving it new clout. As part of the deals, Rentrak guaranteed minimum payments and issued the studios warrants to buy more than 3 million shares of Rentrak stock.

Today, Berger owns only about 4% of Rentrak’s stock. Culture Convenience Club Ltd., owner of Japan’s biggest retail video chain, is the largest shareholder, with about 9%.

In addition to employing its stock to seal deals, Rentrak uses its cash to help grow its distribution base by investing heavily in retail chains. To date, the company has invested or loaned retailers more than $13 million, giving it an inside relationship with several of the big rental chains.

In the last two years, while the rental market has declined, bludgeoned by pay-per-view, the Internet and direct broadcast satellites, Rentrak has flourished. It reported record earnings for the past fiscal year. The increased competition and the need to cut overhead have led many retailers--large and small--to rethink their attitude toward Rentrak.

While it was once a way for the little guy to gain a competitive edge, some little guys now feel they have to use Rentrak to survive.

“You don’t want to be the one guy not using it,” said Jim Howard, president of 24-store Video Galaxy, based in Rockville, Conn.

The typical Rentrak retail customer can pick and choose which available titles it wants to lease. Last year Rentrak offered more than 1,200 titles.

If a Rentrak customer doesn’t lease the title through Rentrak, it’s free to buy the title through normal distribution channels. However, if the retailer does bring in a title through Rentrak, it’s usually required to lease a minimum number of cassettes, based on the size of the store, and it can’t buy any copies of the title through traditional distribution.

The requirements prompt some retailers to look at Rentrak in Orwellian terms. They don’t like the distributor’s demand for minimum buys, nor the mandatory use of Rentrak’s accounting and auditing software, which automatically downloads a store’s sales information to Rentrak’s computers in Portland.

On a more fundamental level, a hot debate rages within the industry about whether the concept actually increases retail revenues.

“I can see where it could be a positive thing if you’re in a very competitive market,” said Steve Mabry, operations manager of the six-store Video Tyme chain, based in Ventura. “But otherwise it’s kind of like having someone’s hand in your back pocket.”

More than anything, some retailers see the Rentrak system as nothing more than a way for the studios to grab more of their revenue, a symptom of the mutual distrust that has always existed between Hollywood and the stores that rent their movies.

The studios are “behind anything that can cut us out,” said Pool of South Shore Video.

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A Model of Profitability?

Rentrak has developed a revenue-sharing system for the video business that it says results in higher profits for both studios and retailers. Rentrak leases titles to stores for much less than it would cost the stores to buy them, and rental revenue is split among the retailer, the studio that produced the movie and Rentrak. Here’s how the numbers compare in a typical scenario, according to Rentrak, based on 5,000 stores bringing in a single title:

Traditional System

* Retailer pays per unit: $60

* Average copies per store: 7.5

* Total units shipped: 37,500

* Rentals per unit at $2.50 per transaction: 50

* Studio cut of rental revenue: 0

* Profit for studios: $2.33 million**

* Profit for retailers: $2.3 million

Rentrak System

* Retailer pays per unit: $8

* Average copies per store: 30

* Total units shipped: 150,000