Blockbuster Battle Over DVDs

Like the tapes and DVDs it rents, Blockbuster Inc. always seems to be living on borrowed time.

Since emerging more than a decade ago as the nation’s dominant video rental chain, Blockbuster has regularly shaken off apocalyptic predictions, whether they stemmed from antitrust suits or looming technology that eventually could allow people to call up any movie they want without rising from their recliners.

Throughout, it has remained the nation’s overwhelmingly dominant video chain, reinvigorated by an internal overhaul and an explosion in DVD rentals as well as a booming business renting video games.

But fast-forward to Blockbuster’s future and things get murkier. Blockbuster’s biggest challenge is shaping up not in courtrooms or over fiber-optic lines but in the shopping aisles of discounters, electronics superstores and even drugstores and supermarkets.

Big merchandisers such as Best Buy Co., Circuit City Group, Wal-Mart Stores Inc., Target Corp. and Costco Wholesale Corp. are taking dead aim at Blockbuster, trying to muscle their way onto the shelves of family home entertainment centers by selling DVDs of “Black Hawk Down” as aggressively as they might sell a new CD by Eminem or Pink.

Price it low enough--say $17 for a hot, fresh title--and people may want to spend a few more bucks to own rather than rent a DVD-quality version of a favorite hit movie such as “Spider-Man” or “Monsters, Inc.” when it is released, especially if it includes extras such as alternative endings and games.

Studios say owners of DVD players are buying about 15 DVDs a year, compared with the five videotapes a year that consumers averaged when that format was at its peak.

“That’s the bigger issue for a Blockbuster,” said Ben Feingold, chief of Sony Pictures’ Columbia TriStar Home Video unit. Feingold said Wal-Mart has become the company’s biggest account, with Blockbuster ranking fourth or fifth.

Although Blockbuster is by far the largest video rental chain, it ranks ninth among DVD sellers. According to estimates from Video Store Magazine, DVD sales totaled $905.5 million last year at leader Wal-Mart and $746.6 million at No. 2 Best Buy, while Blockbuster’s total was $160 million.

Circuit City announced recently that it is dumping videotapes altogether for DVDs. Best Buy has reconfigured its stores to carry a broad selection of films. And stores have found DVDs make good “loss leaders”--products priced dirt cheap to get people into stores, where they presumably will buy other things.

Officials at Blockbuster and its majority owner, Viacom Inc., said they recognize the challenge and vow to adapt, although they question whether the general merchandise and electronics stores will remain competitors when the current hyper-growth driven by the sale of DVD players inevitably eases.

“Blockbuster is principally in the movies business,” Viacom President Mel Karmazin said. “Places like Best Buy and Wal-Mart sell DVDs when they think it generates foot traffic. If they could make more money selling thimbles, they’d replace all the DVDs with thimbles.”

Best Buy Product Manager Peggy Munnagle called the notion that the company uses DVDs only to lure customers into the stores “ridiculous.”

“That’s only accurate for the newest of new releases,” she said. “Everything else we aim to make money on. We plan to be in the business for a long time.”

Behind the shift is the explosion in sales of DVD players. Bob Chapek, president of Walt Disney Co.’s Buena Vista Home Video, said the studio projects the number of DVD players in homes will double in four to five years, from 40 million now to about 80 million.

Chapek said that although renting DVDs remains a healthy, vibrant business, selling them directly to users “is bigger and bigger all the time,” especially now that films are available to buy the same day they can be rented. During the height of the VHS video boom, many films were available only for rent before they were offered for sale at affordable prices.

Because DVDs are cheap to buy from studios, Blockbuster’s rental profit is fat as well. But as the company acknowledged recently in filings with the Securities and Exchange Commission, the competition from mass merchandisers “has increased consumer interest in purchasing movies on DVD and has reduced the advantage to home video retailers” enjoyed when videocassettes were at their zenith.

Blockbuster Chief Executive John Antioco said he is confident Blockbuster can remain competitive on both fronts. The chain’s 5,300 stores are expanding their selections of DVDs for purchase, while keeping intact the company’s rental program, which accounts for about 84% of its business.

The company expects to introduce numerous promotional drives offering discount packages on rentals and sales. It is experimenting with other programs, such as a one-time monthly subscription fee with no late charges that many Blockbuster renters find annoying.

“With the Wal-Mart shopper, I’m not going to stop them from reaching over and grabbing a movie,” Antioco said. “But if someone is leaving their house for the sole purpose of getting a movie, there should be no reason why they should go anywhere else but Blockbuster.”

Antioco added that Blockbuster has no plans to scale back its rental business. To make the point, he quotes a line from one of his favorite movies, “Godfather II,” spoken by gangster Hyman Roth.

“This is the business we’ve chosen,” Antioco said.

Even with the growing competition, Blockbuster’s blue-and-gold stores are likely to be neighborhood fixtures for years. So dominant is the company among U.S. video chains that its annual sales are about 50% higher than the revenue of its next nine competitors combined.

In addition, video-on-demand technology--which would enable people to have at their fingertips the equivalent of an electronic video store--for years was predicted as the Achilles’ heel of Blockbuster, but it remains years away and will require billions of dollars of investment.

Still, for much of the eight years Viacom has owned Blockbuster, the company was something of an unwanted stepchild.

Viacom bought the company for $6.4 billion in 1994 from Florida entrepreneur Wayne Huizenga not because it was enamored with the video business but because the huge cash flow allowed Viacom Chairman Sumner Redstone to finance his $10-billion deal to buy Paramount Communications, parent of Paramount Pictures.

Not long after that, Blockbuster turned into what Redstone calls “a horror story” that was disorganized and specialized in “managed dissatisfaction” because customers frequently found that the movies they wanted already were rented.

“People would come in and were told they could take some 20-year-old picture instead,” Redstone recalled.

In came Antioco, who put in place a program in which Blockbuster bought videos at low prices from studios so it could stock more copies, then shared revenue with Hollywood.

That deal was the core of an antitrust lawsuit against Blockbuster and Viacom. The video company argued it competed aggressively but fairly, and it successfully persuaded a federal judge to scrap the lawsuit without having to put on a defense.

“I make no apologies for anything,” Redstone said.

Redstone and Karmazin said the company has emerged from being a drain to being a key generator of cash for Viacom. In the first quarter, Blockbuster earnings before interest, taxes, depreciation and amortization--a key Wall Street measure of media companies--rose a strong 9% to $175 million.

Even though selling DVDs directly to consumers through major stores is highly profitable for Hollywood (manufacturing costs are less than $1 a disc), analysts say the rental business is so large that studios have no choice but to make sure it stays healthy. A healthy Blockbuster is in their interest, even though the company’s size enables it to throw its weight around in dealing with Hollywood.

“Studios have a real love-hate relationship with Blockbuster,” said Larry Gerbrandt, chief content officer at Kagan World Media, a research firm. “The part they love is the checks they get from Blockbuster. The part they hate is that Blockbuster has periodically tried to use its muscle and leverage.”