Blockbuster, Netflix and Wal-Mart should be paying as much attention to cable’s VOD rollouts as Wall Street, and with good reason: Cable’s video-on-demand offerings have the potential to become more popular with customers than traditional DVD/video sales and rental businesses in the not-too-distant future. No doubt you’ve heard this boast many times over the past decade from cable operators. Despite these promises, VOD still remains a blip on the screen for movie rentals from video stores like Blockbuster and Wal-Mart (which sells more videos and DVDs than any other retailer in the country) and even mail-order companies like Netflix. But things could be different this time around. That’s because video stores’ stock in trade—DVDs and VHS tapes—could vanish as studios try to stem a growing piracy problem and consumers opt for the ease of electronic delivery of their movies. All the more reason for cable to not waste a moment and redouble and refocus its VOD marketing efforts. On the Heels of the Music Biz In an August 2003 research paper, Forrester Research found that one in five juvenile pirates and one in six young samplers downloaded a full-length movie in the previous month. Content producers—both video and music—are coming to the conclusion that on-demand media services have the potential to turn pirate losses into gains, and pirates into paying customers. "Piracy in movies is three years behind what’s happening in music," says Forrester Research VP and lead researcher Josh Bernoff. "While 11% of young people online have downloaded a movie, only 5% report that they buy fewer DVDs as a result. But rather than risk the meltdown that happened in music, studios are responding by embracing all forms of on-demand delivery." Movie studios, however, need to have their anxieties over VOD security and copyright issues eased before they will agree to shorten VOD release dates for their product. Forrester predicts release windows for on-demand movies will come closer to 30-days by the end of the year, an estimate shared by executives at In Demand. Pay-per-view and VOD release windows have traditionally come 45 to 60 days after video rental and sales windows for the same product; a problem that has hamstrung PPV and VOD sales. "A significant number of studios have moved the window to 30 days from 45 already," says Sergei Kuharsky, SVP, marketing, at In Demand. "That’s a 50% drop in the time frame for VOD windows, and we expect more studios to follow suit." Release windows have an impact on how successful a VOD movie is, says Page Thompson, VP, marketing/new products, Comcast. "Video stores like Blockbuster and services like Netflix have their business models, and the release windows are a great advantage for them right now," Thompson says. "But we’re making steady progress in that direction, and the more ways you make it easy for consumers to watch what they want to watch, [the more you] will grow the entire category." Better Marketing, Shorter Windows, More Buys Waiting around isn’t the answer. Release windows will shrink faster if operators get smarter about marketing and delivering the service. All too often, consumers don’t know how to use VOD, are scared to try it and have had problems getting something they’ve ordered. "More people need to know that VOD exists," Bernoff says. "Half the cable companies in the country offer VOD, but most people don’t even know they have it. The business needs an increase in visibility and an increase in usage before any windows are changed. The windows will eventually shrink, but not until some other things happen first." Blockbuster representatives insist they aren’t scared by cable’s VOD potential. Even with improved VOD marketing, Blockbuster spokesman Randy Hargrove says studios won’t mess with windows because they don’t want to damage the lucrative video rental and sales business. "The studios get a $15 gross profit for every DVD that gets sold," he says. "Cable can’t do that. And that is why the windows won’t change." Kuharsky and Bernoff counter by saying VOD’s financial models are attractive. Most of the revenue from DVD sales comes in the first 30 days the movie is available, so allowing the on-demand window to follow after 30 days won’t hurt sales totals. Secondly, movies released to VOD within 30 days of being available at the video store do better in the marketplace, which means more money for studios in the end. In Demand compared the average buy rate per title for all the PPV/VOD movies that had 30-day windows in 2003 to all the 2003 PPV/VOD movies with 45-day windows. The average buy rate for the titles with 30-day windows was double the average buy rate for the titles with 45-day windows, Kuharsky says. Blockbuster executives stand firm that VOD will not grow big enough to replace video rentals. "By 2007, we estimate the rental and sales of DVDs to reach $34 billion. Cable and satellite PPV/VOD will be about $1.4 billion,"Hargrove says. The DVD/video rental and sale business remains vibrant. Consider these statistics: Consumer purchases of DVDs totaled more than $12 billion in 2003, up $3.9 billion, or 46%, from 2002, according to Adams Media Research estimates; consumers spent an additional $4.3 billion renting DVDs in 2003 (through Dec. 21, 2003), up 53% from the same period last year, according to Home Video Essentials. But Bernoff predicts a similarly gaudy future for VOD. He says movie revenue will reach $900 million by the end of 2004, representing "a respectable 3% of the home video market;" DVD sales and store rentals will be duplicated by cable and Internet VOD by 2007-08; and rental revenue from Blockbuster and Wal-Mart will drop 37%, leaving the stores to focus on sales. Blockbuster pocketed $5.9 billion in revenue last year, up from $5.6 billion in 2002, but most of the gain was attributed to acquisitions. Same-store revenue slipped last year for the rental business. After unsuccessfully trying to sell its stake in Blockbuster for months, Viacom decided to spin off the rental business. Meanwhile, cable and satellite will begin eating away at the video rental business over the next couple of years by allowing permanent downloads of content to PCs and DVR hard drives, Bernoff says. Snail Mail on Demand Movielink, a joint venture between MGM, Paramount, Sony, Universal and Warner Bros., has been delivering movie product to broadband users using RealNetworks’ platform for more than a year. The problem is that the movies take an hour or longer to download, and customers have to watch the films on their PCs or be technically savvy enough to connect their TV sets to their PCs. Even then, the picture quality is less than stellar. VOD solves that problem, but the product will requires an immense scale to crack the movie rental and sales business. And when it comes to scale, few companies come close to Blockbuster and Wal-Mart. Blockbuster has 8,600 brick-and-mortar stores as well as a website through which customers can order and buy tapes and DVDs. Wal-Mart has 1,448 regular stores, 1,506 Supercenters, 538 Sam’s Clubs and 67 Neighborhood Markets in the U.S. It also sells all its products via the Internet, which accounts for an increasing number of DVD sales. The Video Software Dealers Association’s 1,500 members operate more than 12,500 retail outlets in the U.S. that sell and/or rent DVDs, VHS cassettes and console video games. By comparision, In Demand’s total VOD universe is 9.6 million (the company also serves another 27 million PPV customers). The total cable VOD universe is around 12 million, although that number is expected to double within the next year. Partly because Netflix enjoys the benefits of video-rental windows, it has worried traditional video rental/sales companies more than cable VOD or PPV in the last couple of years. Netflix’s business model—a subscription service that allows customers to pick DVDs online and have them mailed to their homes with prepaid envelopes and no danger of late fees—has resonated in the marketplace. Wal-Mart has replicated the idea, and Blockbuster hopes to get its Internet rental service off the ground by the end of the year. It’s easy to sign up for Netflix—I signed up without much hassle or any money down and received three movies three days later. Christopher Cox, a Comcast cable customer in Castle Rock, Colo., who currently has no VOD access, signed up for Netflix at the suggestion of his boss, Melanie Dodd, an EchoStar customer who found the dish service’s PPV selection scant and difficult to schedule around. Cox, 31, eventually let his subscription lapse because he didn’t like the lack of spontaneity and found that after about six months it was getting more difficult to get the movies he wanted. Cox is anxious to have Comcast to roll out on-demand movies, although he admits the delayed release window for VOD would be a problem. Until then, he’ll head to the video store when he wants to watch a flick. Dodd, 50, likes the idea of being able to pop in a movie without having to plan ahead, but doesn’t like Netflix’s price. She generally rents three or four movies a month, which translates into more than $5 per movie. Now that Netflix is raising its rates, she is contemplating dropping it. "I’ve not had problems with the service, but I wonder how cost-efficient I am being having PPV on my dish and a Netflix subscription at the same time," Dodd says. "I don’t order that many movies a month, and I’ve not ordered a PPV movie through my dish because it’s generally inconvenient. But I think I will start giving it a try." Wal-Mart found that consumers are very sensitive to price when it comes to its mail-order DVD rental service. The company came up with three price points—$15.54 for two movies at a time, $18.76 for three movies and $21.94 for four movies. There is no limit to the number of movies a customer can rent each month. "We launched the service on June 10, 2003, and we’ve seen superb growth and strong demand for our offerings, particularly the $15.94 price point," says Wal-Mart Online spokesman Amy Collela. She declined to say how many customers Wal-Mart’s mail order service has or what kind of revenue it generates. No Stopping Technology If the music business serves as any example, movie lovers of the future won’t be going to a store to pick up a DVD or receiving one in the mail. The physical material itself is likely to disappear and be replaced by 0s and 1s streaming into the home. Consumers eventually will be able to download films to their TV sets easily, says Paul Delzio, senior director of broadband sales for RealNetworks. Cable operators may be poised to become the leaders in the delivery of on-demand movies, but they risk losing a big chunk of the business if they ignore broadband, he maintains. "Operators have their head in the sand right now when it comes to broadband delivery of movie services," Delzio says. "They think the broadband movie services will cannibalize their VOD product, but that’s the wrong approach to the business. They should look at broadband delivery of movies as a complement to their VOD product and turn it into a revenue generator." There has been little demand from cable operators to include a modem in a customer’s set-top, Delzio says, adding that unless they act soon—within 18 months or so—cable could find itself playing a game of expensive catch-up. For its part, Netflix isn’t interested in delivering movies to customers’ PCs. CEO Reed Hastings told analysts after the company’s quarterly earnings report in April that his company plans to deliver movies directly to next-generation TiVo hard drives. (TiVo’s founder/CEO Michael Ramsay sits on Netflix’s board.) "You can always imagine ways to deliver movies to consumers without using cable," says Forrester’s Bernoff says. "But it is the easiest way to do it, and I think it will prevail. Cable VOD technology works."

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