Video Tape Rental

Industry Snapshot

After rapid growth in the 1980s and early 1990s, video rentals in the United States stalled in the mid-1990s as the market became saturated and as competing modes of entertainment chipped away at home video rental. Then, after the rental market peaked in 2001, video rental stores faced a renewed onslaught of stiff competition from a range of media delivery systems, including pay-per-view television, video-on-demand, and Internet-based video rental subscription services, as well as the increasingly lower prices of videotapes and disks, especially those offered by large retail outlets like Wal-Mart. In addition, as more homes become equipped with broadband Internet access, rental stores face an additional threat from Internet services that offer customers the ability to download movies onto their computers and portable devices. Netflix began marketing online DVD and blu ray rentals, and others, including Wal-Mart, Blockbuster, and Best Buy, soon followed.

The large video chain stores also diversified into other areas such as selling used video tapes and disks, offering trade-ins, selling new and used video games, and establishing Internet-based video rental subscription services, while many of the remaining independent stores survived by catering to a niche market. Despite these moves, the outlook for the traditional neighborhood video rental store was not good as technological advances in media delivery continued.

The video rental business remained fairly fragmented compared to other industries. In recent years, the top six video chains claimed nearly 50 percent of the U.S. market, and with the merger of two chains in 2005, the chains continued to take market share away from smaller, independent video stores. In 2009, the 18,925 rental establishments earned a combined $10.8 billion in revenue.

Organization and Structure

Film studios and distributors sell videotapes and DVDs to rental outlets, which then rent the videos to consumers. Under traditional pricing, rental outlets pay $50 to $80 per video, which they then rent to customers for $1 to $4 per night. Under this arrangement the video store retains all the rental revenues. Increasingly, however, video stores have pursued revenue-sharing deals with studios. These contracts dramatically reduce the stores' initial cost of buying videos, sometimes eliminating up-front costs altogether, and converting them into variable costs by paying the studio a percentage of rental income. Revenue sharing, which came into widespread use in 1998, benefited not only the cash flow of video stores but also frequently boosted overall revenue because stores are able to stock and rent more products.

Typically, the bulk of video store sales were from video rental fees. At large chains like Blockbuster, this can be about 70 percent. The rest came from sell-through videos, whereby new tapes and discs were sold; gaming software rentals for Nintendo and Sony game consoles; snack food sales; and miscellaneous sources such as sales of musical recordings and used videos.

Video specialty stores compete directly with supermarkets, drugstores, and other mainstream retail outlets that also sell or rent videos. Often mainstream stores sell videos at deep discount, creating pricing pressure on video stores.

Videos vs. Theaters.
Video stores have always had a complex relationship with movie theaters. Early on, conventional wisdom held that video rentals cannibalized theater admissions because a typical consumer theoretically would watch a movie either in a theater or at home, but not both. This pattern seemed to hold in the late 1980s and early 1990s, when box-office receipts began to decline as video rentals surged.

The relationship between video rentals and movie-going grew murkier in the mid-1990s as rentals stagnated, but business at the box office swelled. Indeed, in 1996, theater revenues surpassed video store revenues for the first time since 1993, the year rentals first pulled ahead of theaters. To further complicate matters, by the late 1990s, both video stores and movie theaters posted healthy gains. In sum, analysts believed that video stores and movie theaters vied for the same audience some of the time, especially when the economy was sluggish, but each could create demand for the other.

Video Rights.
Owning video rights to films was an important source of revenue for film studios. For example, during the 1990s, roughly half of movie revenues in the United States came from home video, according to a study by Veronis, Suhler and Associates and Smith Barney, Inc. In contrast, revenue from theatrical exhibition accounted for 33 percent of revenues, and television showings contributed 20 percent.

DVD Format.
By the early 2000s, digital video discs (DVDs) quickly became the preferred format for home video viewing, eclipsing videocassettes. Images stored on laser discs are sharper than videotape images, and viewers can move more easily to different places on the recording. Discs can also provide digital stereo audio, which makes them especially attractive for programs involving music.

Digital Format.
By the late 2000s, some DVDs were also sold with digital rights that allowed the user to download a digital copy of the movie to a portable device for viewing. In addition, digital copies of movies could be rented from online vendors such as iTunes and Amazon.com. Normally, the users has a 30-day window to view the movie and 24-hours to finish watching the movie after beginning to view the film.

Background and Development

Although videocassette recorders and players were available beginning in the mid-1970s, pay-TV services were originally more popular. The most popular was the cable network Home Box Office (HBO), which financed films in exchange for pay-TV rights and thus secured exclusive deals on very profitable movies.

By the mid-1980s, pay-TV viewers grew increasingly disenchanted with programming just as home video technology became more affordable and more widely available. Videos offered far more variety and flexibility in viewing for the customer. The cost of VCRs continued to fall from $300 to $400 in the industry's early days for lower-priced models to $150 to $250 in 1993, further contributing to the rise in popularity. By the late 1990s, 84 percent of U.S. households owned at least one VCR.

In the mid-1990s, consumer demand for video rentals began to stabilize somewhat as sales of VCRs began to slow. In 1995 revenues from video rentals and sales actually declined, and rental business was essentially flat for the next two years. Though statistics vary, annual figures compiled by Alexander & Associates, a market research firm for the industry, reported that video unit rentals fell in all but one year between 1995 and 1999. According to the same research, rental revenues managed to stay afloat, largely through price hikes.

On the other hand, sell-through videos had the best performance beginning in the mid-1990s. One explanation for this trend was the decreasing cost of buying videos. In 1995, according to Billboard, quality features from Disney's Buena Vista Home Video were priced starting at $9.99. Other studios followed suit with similar programs.

The industry's 1998 shift toward revenue sharing with film studios allowed video stores to stock more titles at lower up-front costs and helped lift industry-wide revenues out of their mid-1990s doldrums. According to widely cited figures from Paul Kagan Associates, rental revenue in 1998 totaled $8 billion, and sell-through sales reached $9 billion, bringing industry revenues to $17 billion for the year. Though estimates vary, this translated into somewhere between three and four billion videos rented and 676 million videos sold. Sales were predicted to surpass $20 billion by 2002.

Though lauded by many as a major breakthrough, revenue sharing appeared to further entrench a few large chains at the expense of smaller stores, according to both statistical and anecdotal evidence. One reason was that the large chains were able to secure more favorable deals with studios, making the playing field very uneven. Big chains negotiated with studios directly, whereas small stores usually worked with intermediaries. Because small stores received worse pricing, they often opted out of revenue sharing. Meanwhile, their large competitors stocked more videos and had more copy depth, or copies of each video, with a rise in revenue as a result.

Besides revenue sharing, another factor contributing to growth was the popularity of DVD-format videos. In 1998, the number of DVD players topped one million units, and the number was estimated to be three million in 1999. Indeed, by 2007, more than 40 million units were expected to be in use. Sales of DVDs were strong during the late 1990s and continued to the mid-2000s, which benefited the rental market. In 1999, DVDs accounted for only about 4 percent of one leading chain's sales, but that proportion grew at a tremendous pace in the early 2000s as DVDs supplanted VHS.

The conventional video store business competed increasingly with other services that could deliver movies directly to the home, such as pay-per-view and direct-broadcast satellite television. In 1999 pay-per-view was a $1.1 billion business and growing rapidly. A relatively undeveloped technology in the late 1990s also posed a threat. Video-on-demand services, which allowed consumers to receive broadcast movies of their choice at any time, had the potential to lure a large portion of the market away from video rentals and sales. Movies were delivered from the cable provider's digital network at the viewer's discretion. Pricing was similar to pay-per-view and comparable to rental fees, with the option to begin the movies at any time and pause or fast-forward. In addition, the consumer never had to leave home.

On an annual basis, estimated revenue growth for videotape and disc rental employer firms was moderate during the early 2000s. Sales increased minimally from 2000 to 2001, going from $9.16 million to $9.17 million. In 2002, revenues fell 2.3 percent to $8.96 million and then rebounded 7.4 percent in 2003 to $9.62 million. During the early to mid-2000s, video rental stores faced a double threat as DVDs gradually became the format of choice among consumers who opted to purchase rather than rent both classic movie favorites and newer DVD titles because of increasingly lower DVD prices. For those consumers wanting to rent, online subscription services offered the consumer the convenience of renting from home, and because of their compact size, DVDs could be sent through the mail relatively inexpensively with subscription prices reflecting this.

By the early 2000s, advances in digital technology and broadband Internet access changed how consumers obtained movies for viewing. In late 2002, Warner Brothers forged an agreement with CinemaNow by which consumers could download movies to their personal computer on a pay-per-view basis for $3 to $4, usually within 24 to 48 hours. By the spring of 2005, CinemaNow's content partners also included Twentieth Century Fox, MGM, and Miramax. In November 2002, a competing online movie service called Movielink, a joint venture between Paramount Pictures, MGM Studios, Warner Bros., Universal Pictures, and Sony Pictures Entertainment, began serving customers. In 2007, Amazon.com and TiVo teamed up to allow customers to immediately download purchased movies to the TiVo unit, bypassing the computer conversion altogether.

According to a Pew Internet and American Life Project report, by the end of 2004, nearly 60 million Americans had high-speed Internet access at home, while in September 2004, the Nielsen/NetRatings reported that for the first time, 51 percent of U.S. at-home Internet users had broadband connections. As broadband use continued to grow and the technology needed to connect personal computers to home entertainment systems improved, the prospects for movie download services were growing quickly, and they were expected to continue to threaten video rental store revenues in the late 2000s. Despite competition from online movie download services, lower DVD purchase prices, and DVD trade-in programs, however, the fact that the video rental industry continued to be healthy was due in no small part to online subscription rental services, according to Billboard.

Consumers purchased DVD titles in growing numbers, spending nearly $16.1 billion in 2004, up from $979 million in 1999, according to Alexander and Associates, yet consumer spending on DVD rentals also steadily rose beginning in 1999, from $78 million to $8.2 billion in 2004. It was obvious by the phenomenal growth of DVD purchases and rentals at that time that DVDs had become the format of choice at the expense of the VHS format, which faced extinction. As illustrated by the Alexander and Associates market figures, VHS rental spending peaked in 2000 at $11.6 billion. Consumers spent $7.39 billion on DVD rental and $7.67 billion on tape rental in 2006. In 2005, 97.7 percent of households owned VCRs, and 84 percent owned DVD players. By 2007, two million "next-generation" high definition DVD players (HD DVD) were in U.S. households, providing a need for the availability of compatible formats.

Current Conditions

In the late 2000s, the video rental industry was at a crossroads. The traditional mom-and-pop retail outlets were all but gone from the landscape, and Blockbuster, the world's largest retail renter, was struggling as the economy was in the middle of a recession, and consumer discretionary spending was down. In addition, Blockbuster was facing increasing competition from multiple fronts. First, for several years, online subscription service Netflix had been digging into its market share, and more firms were joining in, including Wal-Mart and Best Buy. Second, Redbox was nearly doubling its operations annually in the late 2000s, renting DVDs for $1 per night from thousands of kiosks placed in discount and grocery stores. Third, cable television, satellite, and TiVo services were vying for a share of the market by offering video on demand. Finally, as technology became increasing digital, several players, including Netflix, Apple, and Amazon, were working to claim the majority of the market for video streaming.

By 2009, Blockbuster was rolling out its own version of kiosks to compete with Redbox. However, Redbox was clearly making an impact on the industry--one about which the major studios were not pleased. In 2009, both Fox and Universal initially refused to deal with Redbox, claiming that the company severely undervalued its product by renting new releases for $1. The studios placed a 30- to 45-day hold on new releases before turning them over for distribution in Redbox vending machines. However, when Redbox, which buys 300,000 to 500,000 of each title, filed suit in August 2009, the studios acquiesced; Redbox agreed to a multimillion dollar settlement to pay for the right to sell the studio's products immediately on release. The company expected to have 22,000 kiosks by the end of 2009--a number that could double again by 2012.

What appeared to be at issue for the rental industry is not whether rental would eventually convert to streaming but when. Some experts expected DVDs to begin to be phased out by 2014, whereas others looked down the road to closer to 2020. Nonetheless, instant access by video on demand, streaming, or downloading video was expected to outpace DVD rentals in the coming years. In 2009, Thomas R. Umstead noted in Multichannel News, "The provider that can deliver the most convenient home-viewing experience at the best price with the strongest customer service support and greatest selection of content will be the winner in what's expected to be a lucrative, digital movie rental future."

Industry Leaders

The undisputed leader of the video rental store industry was Blockbuster, Inc., known as "Big Blue," which until late 2004 was owned by media conglomerate Viacom. Despite its dominance, Blockbuster's corporate performance has been spotty. Although its revenue saw significant growth beginning in the mid-1990s, it continued to run net losses and rack up heavy debt. Blockbuster's earnings weakness was an ongoing source of friction with its former parent Viacom which was pressured by investors to sell the video rental unit. In 1999, Viacom sold 20 percent of Blockbuster's stock in a public offering and finally divested itself from the remainder of the company in 2004. Blockbuster hoped that its transformation to meet the challenges of the rapidly changing home entertainment market and the declining video rental business would be successful. In 2005, according to "Fortune," only about 65 percent of a typical Blockbuster store was devoted solely to rentals, with the remaining space offering gaming centers as well as new and used DVDs and videogames for sale or trade-in. In August 2004 Blockbuster entered the lucrative online subscription market, going head-to-head with services like Netflix. Its online service added 700,000 subscribers in the fourth quarter of 2006 alone. With its 7,100 company and franchise stores in over 20 countries (about 60 percent are in the United States), Blockbuster in 2008 posted $5.29 billion in revenue. In the late 2000s, Blockbuster announced that it would divest of its international business segments to focus on converting its domestic operations to be fully functional as the industry continues to go digital .

Movie Gallery, the second-largest video rental business in 2009, purchased rival Hollywood Entertainment in 2005 for $1.2 billion. The Dothan, Alabama-headquartered rental chain had 3,300 stores nationwide and in Canada and Mexico in the late 2000s, down from a peak of 4,800 in the mid-2000s. The company posted a net income of $2.29 billion in 2008 and was struggling to emerge from Chapter 11 bankruptcy.

Online-only merchant Netflix rapidly grew in popularity and revenues. With 10 million subscribers in 2009, the company offered customers the chance to select from over 100,000 movie titles online, which would then be mailed to them, with no applicable postage charges, late fees, or due dates. Subscribers instead paid a monthly fee, the amount of which was dependent on how many titles they want to check out at a time. In the late 2000s, Netflix cut a deal with TiVo so that customers, using TiVo's latest equipment, could record some 12,000 Netflix titles directly to their televisions.

Redbox, owned by Coinstar, was the newest player in the market. Redbox is a kiosk-style rental service. Red kiosks are placed at fast food restaurants, supermarkets, and discount centers. Renters can reserve a title online or at the kiosk. The fee is $1 per night; there are no late fees and no membership fees, and the movie can be returned to any Redbox kiosk. Each of the 22,000 kiosks around the United States in 2009 held 700 DVDs (200 titles). Coinstar expected to double the number of kiosks by 2012.