Parks Associates Blog

Wednesday, August 15, 2007

Blockbuster, Google, and Lessons Learned about Broadband Video

The advent of digital distribution for theatrical, television, and user-generated content comes at a time of enormous pressure for the traditional entertainment industry. After enjoying years of strong box office and DVD rental and purchase revenues from the late 1990s into the early part of this decade, growth in U.S. revenues has slowed significantly. After averaging a healthy growth of around 8% between 1996 and 2002, box office revenues haven’t budged since 2003 (and in fact declined nearly 6% between 2004 and 2005 before rebounding 6% between 2005 and 2006). DVD rentals and sales have also lost their luster in recent years. After very strong growth between 2001 and 2004 (nearly 240%), DVD sales revenues were close to flat between 2005 and 2006. DVD rental revenues have also settled into a slower growth rate in 2005 and 2006 – around 10-14% by many estimates.

Television networks have similarly struggled with the impact of digital distractions (the Internet, game consoles, DVRs, etc.) that have gradually eroded the primetime audience for many programs (American Idol notwithstanding). Their revenues have been impacted in the form of decreased ad "upfront" ad sales (typically referring to the early buying of advertising for the fall primetime season). In June, The Wall Street Journal reported that upfront sales had rebounded slightly compared to previous years, but television networks continue to reevaluate their ad strategies as major advertisers seek alternative outlets, particularly the Internet. When an online video service such as Joost can land 30 major brand-name companies as primary advertisers (among them Coca-Cola, Nike, and HP), you definitely sense that the rules for traditional media have officially changed.

We've been watching how both traditional and upstart media outlets have been addressing digital distribution, culminating in a report that was co-authored late in 2006 by Michael Cai and me (Internet Video: Direct-to-Consumer Services). In that report, we found that while big media of all types were actively engaged in digital distribution of some form, pure user-paid movies-on-demand services would consitute a much-smaller pie of total U.S. revenue than ad-supported models, including the work of the major TV networks to put delayed primetime programming on the Interenet - embodied by the efforts of, CBS's Innertube, NBC's Rewind, and Fox Corp.'s MySpace. So far, this has held true, as the major broadcasters are still reporting good returns on their Web properties (as in an active viewership, no signs of cannibalization, and the ability to charge higher rates for ad inventory). Outside of the iTunes TV show and movie download service (which at last report had generated 53 million downloads), we indicated that the user-paid services - and particulary those specific to movies would face hurdles. In the report, we wrote:

"Internet Video for movie content faces stronger challenges in terms of technological challenges, resistance from major retailers, lack of easy connectivity between broadband services and the television, and the continued consumer reliance on tangible media."

Our own consumer data backs the notion that the early successes for broadband video are certainly those efforts more focused on shorter ("snackable") videos, versus a movie download. The good news is that the number of broadband users reporting paying at least monthly to download or stream video doubled between 2005 and 2006 (we compared data from a couple of our studies - Digital Entertainment: Changing Consumer Habits and Digital Media Habits). Five percent of broadband users in Q3 2006 reported paying for video streams and downloads. We're going to be really interested at the results from Digital Media Habits II, which should be available quite shortly. However, consumers active in watching video on the Internet were twice as likely to be downloading short clips (such as movie trailers, news clips, animated cartoons) than longer videos such as feature-length movies or TV shows).

The challenges of selling premium video content have been reflected in a couple of significant announcements from the user-paid broadband video space. First, it was announced on August 8 that Blockbuster was acquiring the online movie service Movielink. Now, rumblings about Blockbuster's potential acquisition of Movielink had been around since March, when the purchase price was rumored to be $50 million. In last week's news articles, the purchase price was rumored to be $20. It turns out that both of these price points were off by several multiples. In an August 14 SEC filing, Blockbuster reported that it had purchased Movielink for $6.6 million in cash. For a service that was created from a reported $100 million in investment from the major movie studios, this is one clear sign that a pure movies-on-demand business over the Internet just isn't ready for primetime.

The second broadband video announcement of significance came on August 13, when Google dropped its user-paid video services, the Google Video Store. Both of these news items certainly reflect the continued challenges facing the online services, but also opportunities for content developers and distributors. We wanted to share a few thoughts about both of these news items.

Blockbuster Seeks an Edge

As a company, Blockbuster’ experience in the video distribution business largely mirrors the opportunities and threats for the industry as a whole. As a movie rental company, Blockbuster’s reach in the U.S. is unparalleled. The company operates more than 5,000 stores in the United States and its territories. In 2006, Blockbuster reported gross profit of more than $3 billion on revenues exceeding $5.5 billion. However, the company’s financials have declined in the last two years. In 2006, Blockbuster experienced a 3.1% decline in DVD rental revenues and an 18% decline in DVD sales revenues. Blockbuster’s core rental business has been under pressure by Netflix, which held a nearly three-to-one margin of subscribers to its online DVD rental service than Blockbuster. Mass retailers, Blockbuster notes, also serve as a threat to its DVD rental and sales businesses because of a movie studio practice known as “sell-through pricing.” This means that the studios release nearly all DVDs to retailers at a price low enough to allow them to entice customers with a small mark-up of the price on their end. For large volume retailers such as Wal-Mart or Target, this is less of a challenge, as they can sell higher volumes of movies than a Blockbuster. For Blockbuster, however, this puts pressure on them.

Blockbuster is no stranger to experimentation with online content. In 2000, it announced a deal with Enron and other broadband providers to deploy a video-on-demand service over 1.5 Mbps DSL lines. Needless to say, given the collapse of Enron and the fact that broadband connections were not nearly as widespread nor as robust as they are today, that the effort was shelved. Now, Blockbuster has announced the purchase of Movielink, one of the first online movies-on-demand services that was established by the major motion picture studios in 2002.

The recent commentary and analysis from major news and financial media outlets has provided an interesting insight into both Blockbuster’s business and predictions about the overall broadband video-on-demand space. Our own takeaways from this sale include the following thoughts:

  • Blockbuster is perceived as a follower of Netflix. Netflix initiated the online DVD rental business in 2001; Blockbuster began its online DVD rental business in 2004. Netflix announced its digital movie service in January 2007 (and it was commercially available in June 2007); Blockbuster announced its acquisition of Movielink in August 2007.
  • Blockbuster’s brick-and-mortar retail stores are seen by the investment community as both a blessing and a curse. They are a curse, because they account for high overhead. However, recent comparisons of the growth of Blockbuster and Netflix’s online DVD rental businesses indicate that Blockbuster has been experiencing much higher growth in the last year, probably because the retail stores are available for more flexible rental options.
  • Movielink et. al. hasn’t been popular because of restrictive digital rights management that doesn’t provide full flexibility. We'd also argue that the lack of freshness of the content is also a reason. Why use a movie download service if the content isn’t any newer than what one could get via a DVD rental?A more successful model for broadband video is wide distribution of content across multiple aggregators, as opposed to creating exclusive portals.
  • A more successful model for broadband video is wide distribution of content across multiple aggregators, as opposed to creating exclusive portals. An early lesson learned by the TV broadcasters was that - certainly in this early stage - that exlusive portals providing only one source for accessing the content is a non-starter among an ever-fragmented audience. Certain pockets of the viewing audience, including teens and ethnic groups, are already dramatically changing their media consumption behavior. As the viewing audience becomes fragmented, the channels need to diversify. For media companies trying to establish their own online presence, it is essential to define a clear identity for each of their online channels.

Google Bails on User-paid Content

The Google Video Store was announced in January 2006. This service provided a variety of video, including sports, movies, and TV shows. Google offered these programs for download or rental at prices ranging from about $1 to $20. Although Google's ability to drive revenue from search-generated ads is unmatched, the company - according to critics - struggles in areas outside of this core competency. The Google Video Store was one of these areas. Critics such as David Pogue at The New York Times panned the site its poor design and for not allowing users to play copy-protected content on portable devices such as iPods and notebook computers. Second, Google faced an identity crisis of sorts in providing user-paid and relatively high-value content while at the same time pursuing (and ultimately acquiring) YouTube, which was made famous (or infamous, depending on one's stance) by providing lots of user-generated video and for (in some cases) serving as a clearinghouse for copyrighted content. One could argue that Google's efforts managed to alienate two key constituencies - users who critized a lack of flexibility in enjoying their paid video, and owners of high-value content, suspicious of Google's motives and upset that YouTube wasn't (in their minds) acting quickly enough to squelch the posting of copyrighted content.

On August 13, 2007, it was announced that Google shutting down the user-paid service, ending the 19-month experiment. Our takeaways from Google's pullback including the following thoughts:

  • Google’s own YouTube posed a threat to a user-paid video service. Google is struggling to gain credibility with major content producers, because the YouTube site has come under fire for its use as an illegal distributor of copy-protected content.
  • As in the case of Movielink, consumers struggled to find value with copy-protected broadband video when 1) much of it was free to view (illegally) on YouTube (or peer-to-peer sites); and 2) a DVD can be played pretty much anywhere.
    Google’s core strength lies in ad-supported Web content, and it has struggled with challenging PayPal with Web payment schemes. This means that advertising will be Google’s “currency” of choice for generating revenues on the Internet.
  • Google has sown the seeds of discontent with consumers, who feel burned about having paid for broadband video clips and who longer have access to that content. This can raise even more skepticism about the broadband video services – why would a consumer trust any of these sites versus buying a DVD that they can own “forever?”


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