Shattering Windows

November 2007

A funny thing happened on the way to salvation.

For years the booming DVD market has been hailed as the savior of a Hollywood whose bottom line has been besieged by spiraling production costs and—more recently—as a cash-generating aftermarket for producers of TV content.

But, in a pattern endemic to the entertainment industry, a newer technology is menacing an older one. This time, digital distribution is threatening to slow down the DVD juggernaut, which is already hobbled by product glut and dropping prices.

This presents content producers and distributors with a combination of fresh challenges and alternative choices. As they continue to exploit the maturing DVD business, they realize the need to embrace new forms of electronic delivery like video on demand (VOD).

None of the players are calling DVDs a growth area anymore. “The DVD market is weakened from last year,” says Mark Lester, the president and CEO of American World Pictures. “It varies on a territory-by-territory basis, but it has definitely gone down in the independent sector. There has been increased competition from studios making direct-to-video product, and also competition from other consumer platforms like the Internet and video games.”

According to Lester, territories most affected by the DVD slowdown include Spain, Italy and parts of Asia—but consumers everywhere are getting more selective. “It is becoming a cherry-picking market in which quality rises. If you have a really good film, that’s the one the DVD companies around the world will put their money on—promoting it and marketing it. But the market for failed productions is very limited now, whereas in the past we were able to sell everything. Now it has to be a really good movie that everyone wants to see.”

“The DVD market is experiencing some retail price pressure in those countries where DVD-player ownership has had high penetration for many years,” adds Mark Kirkpatrick, the senior sales executive of home entertainment for Eastern Europe, South America and Iberia for Granada International. “Additionally, there has been a decline in the rental sector over the past few years.”

“Major retailers have noticed that DVD sales have been softer than anticipated recently,” concurs George Shamieh, the CEO of American Cinema International (ACI). This results, he says, from “a combination of more product being introduced into the marketplace, proliferating choices, and cheaper pricing for consumers.”

Cord Douglas, the president of distribution at Cinamour Entertainment, is even more pessimistic. “The current health of the DVD market is like that of a wounded animal,” he says. “In general it doesn’t generate the revenues it used to. If it gets stirred up by a strong title and name talent it can be ferocious. But the pricing of DVDs is at an all-time low and the marketplace is flooded. We see many DVD distributors lowering minimum guarantees, as well as expectations.”

Nevertheless, just as the health of the DVD market varies by territory, sales also vary according to demographic groups. DVDs are especially popular now among “the very young and the very old,” says Ken DuBow, the president of worldwide distribution at PorchLight Entertainment and its new subsidiary, Condor Releasing. “Those groups are always the last adapters in anything. So we’re looking for sell-through product that appeals to younger and older people. That’s where you’re seeing the greatest percentage of growth in terms of DVD buying. The middle is static right now.”

Following classic laws of supply and demand, this marketplace glut and its resulting downward pressure on retail prices is affecting studios and independents alike. “The major studios lower prices to remain competitive with rival studios, and independents are forced to release product at lower prices than the studios,” notes Cinamour’s Douglas. “When evergreen studio films like Die Hard are available on DVD for $9.99 or less, it’s very hard for an independent film without a theatrical release to be priced higher and succeed.”

$43 BILLION

Yet it’s not all gloom and doom, and DVDs are hardly about to disappear. Far from it. “Globally, the DVD business is worth around $43 billion, so it continues to be a lucrative market,” says Pete Kalhan, the senior VP of home entertainment and archive sales at FremantleMedia Enterprises. “It isn’t growing at the previous rate. The market is maturing and leveling out, [but] for those who have the right content, the right marketing and the right team, it is still a great business to be in.”

“DVD is a big business and a very important market for us,” says PorchLight’s DuBow. “Even as you see reports on a worldwide basis that the DVD marketplace is decreasing, you’re talking about such a big, multibillion-dollar marketplace that those decreases don’t affect the kind of business we do. There are still a lot of healthy buyers out there.”

DuBow cites continued strong interest in DVD rights at the television markets. “A lot of sub-distributors come to markets like MIPCOM and are looking to buy all rights from us,” he says. “The DVD market is probably the greatest revenue part of that.”

Smaller, independent companies “operate on a different altitude” from the majors, notes ACI’s Shamieh, and some of their niche programming “remains strong and continues to have strong potential.”

That’s because many independents happen to be dealing in some product that is often well suited to DVD distribution. “Male, young-skewing, action or horror titles tend to work on DVD,” says Fernando Szew, the CEO of MarVista Entertainment. “Some family titles also work well.”

Still, other genres that formerly found success in the DVD market have declined drastically in popularity. “Certain children’s titles, unfortunately, and fitness titles, which were big DVD categories for us, don’t have the positive numbers they used to,” Szew laments.

For ACI’s Shamieh, it’s comedy that will always fare well, because “people want to be entertained. Laughing takes them away from their daily stresses.” He adds that “families are also looking for more programming that they can watch with their kids. We believe spiritual, faith and family features will remain popular along with action and horror.”

For Michael Heap, the CEO of Entertainment Rights, which owns Classic Media, it’s also family programming that works best. “Year after year, perennial seasonal properties thrive in the DVD marketplace,” he says. “One reason is the enduring appeal and desire to pass on the memories to a new generation.” Preschool programming also remains in high demand, he notes, as kids love to watch their favorite shows over and over again.

Over the years, as home-video technology made the transition from VHS tape to DVD discs, its predominant business model has shifted from rentals to sales. “The rental market has vastly decreased in importance throughout the world,” notes MarVista’s Szew. “Overall, DVD has become a sell-through business.”

There are several reasons behind this phenomenon, including the fact that DVD sell-through prices are dropping quickly, coupled with the desire of people to simply collect DVDs, Szew believes. “People still want the physical good and to have a library in their home,” he says, “especially if they can buy it for a single digit, like $9.99, or €9.99.”

“The business is going into a sell-through mode,” agrees ACI’s Shamieh. “While the changes depend on the territory, overall the business for films on DVD is moving away from rental.”

American World Pictures’ Lester concurs, and cites numbers. “In the U.S., it’s now 15 percent rental and 85 percent sell-through,” he says, “and it’s moving more in that direction.”

TANGLED UP IN BLU

No observer of the DVD scene—whether a Hollywood studio chief or a consumer at retail stores—has failed to notice the format war that’s being waged between the two rival high-definition DVD formats for domination of the marketplace. The Sony-backed Blu-ray DVD system is fighting it out with the HD DVD format from Toshiba. Different studios have backed different systems, and the players of either system cannot play the discs of the other.

“We think Blu-ray is the best format going forward for a lot of reasons,” says Michael Lynton, the chairman and CEO of Sony Pictures Entertainment. “The quality, the content advantage, the encryption, the disc’s capacity to do many things. More of the consumers’ favorite movies will only be available on Blu-ray disc. Blu-ray is outselling HD DVD more than two to one, and [most] of the eight major studios support Blu-ray.”

The marketplace battle is “causing consumer uncertainty,” says FremantleMedia’s Kalhan. “People are reluctant to invest in either technology for fear that one may fold, as was the case with the VHS/Betamax war. The knock-on effect of this is that it has slowed the growth rate in the DVD market as consumers wait to see which format will be the victor.”

For similar reasons, independent distributors have also stayed away from high-definition DVD, or maintained a neutral attitude. “As program suppliers, we haven’t been affected by the format war,” says Cinamour’s Douglas. “Our DVD distributors are free to release titles on either format or both without restrictions, unlike some of the studios that have endorsed one format or the other.”

Similarly, Granada International is hedging its bets by “making available content suitable for Blu-ray and HD DVD creation through a huge program of restoration and digitization of classic and cult films and TV series,” says Kirkpatrick. The digitized material is easily transferable to either high-definition DVD format.

DOING WINDOWS

The issue of sequential release of content across various platforms is a complex one that elicits a variety of opinions. Most agree that the window between theatrical release and DVD release is shortening.

“The studios are under more pressure to show a gain each quarter,” notes ACI’s Shamieh, “and DVD sales certainly help them in this area. [But] you have to be careful, as you don’t want those windows to be too short, too quick.” In general, he adds, DVD release windows are shorter for box-office flops, with studios using DVDs “as a crutch to help counter the underperforming numbers.”

“Yes, the windows are getting shorter, mainly in order to fight piracy,” says FremantleMedia’s Kalhan. “The downside has been the decline in the rental market and the price erosion we’ve seen at retail. So while volume is up, value is either stagnant or showing a slight decline.” Kalhan is hopeful that emerging markets like China, India and Russia can make up for the shortfall.

“We’re seeing the window [between the theatrical and DVD releases] being shattered quickly,” says MarVista’s Szew. “But there’s been resistance because the theatrical experience is so different from home or mobile viewing. We might see simultaneous release for certain types of titles, but not all. Some of them will remain event viewing, others might not.”

PorchLight’s DuBow, however, sees little change in this arena. “Some of the studios have experimented trying to get their DVD releases a little bit closer,” he says, “but they’ve found tremendous resistance among their exhibitors, and rightfully so. The theatergoing experience is the ideal way to see a movie. You cry, you laugh, you get scared. It’s important to have some sense of exclusivity on the bigger films.”

“I think it’s best to preserve the sanctity of the theatrical release,” agrees Cinamour’s Douglas. “Too much revenue will be lost by audiences staying home and paying a small video rental fee rather than taking a group of people to theaters and paying for separate tickets.”

Still, there’s always chatter in Hollywood and other quarters about simultaneous day-and-date release of movies in theaters and on DVD, and a few companies have actually experimented with this total window collapse.

The most notable is HDNet, founded by the billionaire entrepreneur (and recent Dancing with the Stars contestant) Mark Cuban, which has released his independent product on several platforms simultaneously—including the theaters of the Landmark chain, which he co-owns.

“I’m not sure how much success they’ve found with that formula, except they’re only working with smaller movies,” notes Douglas. “It’s not like you’re risking Spider-Man money here.”

“In my opinion, any exhibitor showing properties under simultaneous release would be committing suicide,” says ACI’s Shamieh. Moreover, he disagrees with those who say this practice would stop piracy. “Piracy is for personal financial gain only, and regardless of whether programs are released simultaneously or not, the piracy would continue.”

But while the window between theatrical and DVD releases—although shorter—remains open, the window between television and DVD releases seems to be closing.

Gene George, the president of Regent Worldwide Sales, has noticed that in the past year some of the DVD distributors in various territories to whom he sells Regent’s made-for-TV movies have stopped insisting on a holdback against television broadcast.

“It seems like some of the windows are collapsing there,” he says. “Typically, a DVD distributor would like a holdback against television, but because the market has gone in the direction of sell-through, some distributors don’t object as much to [the product] airing first on television and, in fact, are looking at the TV broadcast as more of a marketing tool to promote the movie and make people aware of it so they will actually go out and buy the DVD.”

For example, says George, “if one of our action thrillers or holiday films airs on TF1 in France or Telecinco in Spain, that creates an awareness in the marketplace that the DVD distributor can use as a tool to sell the DVD.”

GROWING DEMAND FOR VOD

Video on demand is an inclusive term that describes several forms of electronic program distribution on a variety of platforms, including digital terrestrial television, cable, satellite and broadband.

“The U.S. is so far in advance over everywhere else in terms of VOD and SVOD,” says Joel Denton, the president of production and distribution at RHI Entertainment, whose offerings include the new mini-series Tin Man and Shark Swarm. “In Europe, [the take-up of viewing] on PC screens rather than TV screens is still slow. It’s important and it’s going to be really important, but it’s still relatively slow.”

While the VOD landscape is far from clear, and large media companies are experimenting with several business models, the technology basically falls into three areas, according to Martin Blakstad, the head of new media at Granada International.

“The term ‘VOD’ needs to be broken down into catch-up [the British term for what is called streaming in the U.S.], download-to-own (DTO) and download-to-rent,” he explains. “Video on demand” and its companion, “subscription video on demand” (SVOD), generally refer to download-to-rent, he adds.

“Catch-up and DTO are definitely fast-growing markets, and we are doing increasing numbers of deals worldwide where we license the rights for these two additional windows of exploitation,” Blakstad says. “We do not see VOD growing as fast, nor are we having such a large number of requests for these rights at this stage.”

For PorchLight’s DuBow, download-to-rent is the digital equivalent of the physical rental experience. “If you pay a VOD price comparable to a rental fee for the program, it will have a limited number of runs before it disappears off of whatever device you’ve put it on. That’s because you paid what you would have paid to rent it at a Blockbuster store.”

What Blakstad calls DTO, DuBow calls electronic sell-through (EST), which is the digital equivalent of buying to own. “That’s totally different from the VOD or the rental experience,” he says. “It’s a pricing thing. If you pay a sell-through price for it, you own it. It doesn’t disappear.

“And it doesn’t matter whether you call it VOD or something else. If you buy it at retail at a Target or a Wal-Mart store, it’s yours. And those stores, like the film exhibitors, are putting a lot of pressure on the studios to keep their digital [DTO] pricing in line with the retail pricing.”

But for most distributors, especially the independents, video on demand is not yet a real business. “VOD will really be a boon if it ever comes about in any major way,” says American World Pictures’ Lester. “Right now we have very little revenue from it. It’s the major studios that are moving in to capitalize on it.”

And small wonder. Even though it’s still a small slice of the pie, it’s a tantalizing target. “The studios are getting about 85 percent of the revenue generated from VOD purchases, but only about 20 percent from DVD purchases in the sell-through market,” says Lester. “So they’re looking to move their business completely into VOD if they can.”

And such studio initiatives may pave the way for independents. Lester believes that once the studios train the consumers to view and buy content via VOD, independents like American World Pictures will follow them and take advantage of the new consumer habits. “That concerns the retail stores, but if it goes in that direction it’s better for the independent film world,” Lester adds.

The pluses of electronic distribution include the fact that there are no manufacturing costs, says Lester. On the negative side, however, he wonders how independent films would market themselves for VOD. “In the video store you can see the packaging. You can create fantastic key art for the stores. That way people look at it and they want to see the movie,” he says. “But I’m not sure how we market VOD to the consumer.”

Regent’s George is also cautious. “We have a lot of interest in VOD,” he says, “but I’ve made the decision at this point not to initiate deals in that area until it stabilizes and maybe the market picks up some more.”

Nevertheless, Regent has dipped its toe in the VOD waters. “The only VOD business I’ve done up to this time is in situations where we’ve concluded a deal with a major broadcaster and they’ve got some kind of alliance in the VOD arena, and we feel they’re a good partner to exploit it,” he explains. “In those cases specifically, we do them as a split deal. We don’t give the broadcasters the VOD rights for free. They’re carved out from the broadcast deal and any revenue that’s earned from VOD is split between us.” The proportion of the split can vary from deal to deal, he adds.

George is optimistic about the future of VOD as a revenue source for a company like Regent, but thinks that “it’s probably 12 months away before there is some value coming out of there. The numbers are still pretty low. But a lot of films are being put out there, and as soon as the market gets its foothold it could be meaningful for us. We just don’t think it’s there yet.”

DIGITAL VS. PHYSICAL

There’s little doubt within the industry that digital distribution of content will grow significantly—even threateningly. “Eventually, as digital cable systems and computer systems become more powerful—with enhancements in picture quality and storage capacity—and as younger generations accustomed to downloadable product grow older, VOD will outpace DVD,” says Cinamour’s Douglas.

In the opinion of Granada International’s Blakstad, the DTO flavor of VOD “has the potential to cannibalize the DVD market to an extent, and the DVD rental market will certainly be impacted.” He adds, however, that several issues must be resolved before VOD can take off, including the image quality of broadband delivery. “We see the two markets developing differently. VOD will enable more spontaneous purchases while the DVD market will be a premium product with guaranteed high-quality images, added features, and will fill the desire to own something physical.”

But while the trend today is toward digital distribution, “I think that physical distribution will not just survive, but also thrive,” says MarVista’s Szew. “Look at books. They’ve survived. They’ve thrived. The business model has changed from what it was five or ten years ago, but books continue to be with us. Physical and digital distribution will live side by side.”