How Hollywood Cheapened Its Product

Through their mindless willingness to sell DVDs to Redbox and Netflix, the studios have cheapened their entire food chain

In 1997, Sumner Redstone warned Hollywood studios that the video store business was going into the toilet if it didn't get some help. His company, Viacom, then not only owned Paramount, but Blockbuster Entertainment as well. Rentals from Blockbuster's 6,000 stores put $3.9 billion dollars in the six major studios' pockets, and he argued that studios “can't live without a video rental business. We are your profit."

As a result, the studios agreed to share the cost of stocking Blockbuster's stores in return for a share of its rental revenues.

He won that battle, but lost the war.

Thirteen years later, two-thirds of America's video stores have closed and Blockbuster has gone bust. In April 2011, Dish Network bought it out of a bankruptcy auction with plans to convert what remains of its rental store business to streaming a la Netflix and movie vending machines. The other major rental store, Movie Gallery, had liquidated its 4,700 stores in April 2010.

"The store model is now dead," a former top executive close to Blockbuster wrote me recently. "The move to $1-per-day rentals has done it in."

The pioneer in dispensing $1 rental DVDs out of kiosks in fast-food restaurants and supermarkets is Redbox. It was created in 2004 as a joint venture between McDonald's and Coinstar, which then bought out McDonald's. By doing away with clerks, real estate leases, and the store itself, Redbox created a business model with which no brick-and-mortar stores could compete.

Redbox did have a stumbling block: It had to finance the purchases of new titles weekly. To get the wholesale price of $15-$18 per title from the two main wholesalers, VPD and Ingram, it needed a large minimum order.

"The capital needed to fill the . . . machines was outstripping Redbox's earnings," said one person involved in the business.

The irony here is the studios provided Redbox a solution. To please an angry Wal-mart, the studios' largest DVD customer, which sold most of its new titles in the first two weeks of their release, they needed to delay Redbox releases. So Warner Bros. and Fox made a deal in which Redbox delayed its rentals for 28 days, in return getting the revenue sharing that Redstone had gotten for Blockbuster a decade earlier.

Redbox got its titles at a lower cost, and didn't need to raise capital for large advance payments. Even splitting the rental revenue with the studios, it worked out to no more than it had previously paid wholesalers.

Redbox resumed its explosive growth in 2009-2010. This became the tipping point.

The other nail in the video store coffin came from Netflix. In October 2008, it added free streaming of movies and TV series to its $8.99 mail-in service. Content was sub-licensed from Starz at a bargain price. Brick-and-mortar stores couldn't compete with $1-a-day rentals and free streaming.

Even with video stores dying, the studios did not lose entirely. While they made about 50 percent less from $1-a-day revenue sharing, Redbox and Netflix, along with Walmart, became their biggest customers. A slim-downed cash cow is better than none.

In 2010, for example, Time Warner harvested nearly $4 billion from its home video unit (i.e., DVDs and Blu-rays), which, though about 30 percent less than the peak in 2007, was still a rich lode. Other major studios did almost as well.

The losers included indie and lower-budget movies. Redbox concentrated on the wide-opening Hollywood films that have been hyped with $30-50 million ad campaigns. Since there is limited space in vending machines, indie movies are often not carried.

That leaves Netflix. But as Netflix moves from physical DVDs to streaming, it no longer needs to purchase DVDs. For indie producers, this is nothing short of a disaster.

Another casualty is original TV series. Streaming has all but wiped out the sale of boxed sets, and without such prospects, networks are cutting back on producing additional seasons. Netflix has tiptoed into the breach, helping to finance one new original series and the 5th, 6th and 7th seasons of “Mad Men.”

But such deals are few and far between.

Through their mindless willingness to sell DVDs to Redbox and Netflix, the studios have cheapened not only DVDs, but also their entire food chain. If the public becomes accustomed to renting videos for only $1, it will value others forms of the product, including movie theater tickets, DVD purchases, and internet downloads accordingly.  

So the great devaluation is just beginning.