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Game theory in the popular press.

A Game of Chicken

Video Business
Commentary
Paul Sweeting
March 22, 2002
text is a cache of http://www.videobusiness.com/article.asp?articleID=2497&query=Game%20of%20chicken&catType=

The development and introduction of the DVD format was a rare case of Hollywood deploying technology in a premeditated effort to alter the economics of the movie business.

When the VCR was introduced in the late '70s, it had a radical effect on studio economics, introducing an entirely new revenue stream for movies and cementing the pattern of releasing movies through a series of exclusive windows. However, almost none of that was planned, or even foreseen, by the powers that be in Hollywood.

Hollywood's initial reaction to home video technology, in fact, was to try to kill it in its crib, first suing to block or at least tax the sale of VCRs and then seeking congressional support for suppressing the rental market.

When TV was introduced, the studios saw the sky falling in on the movie business. That is, until they realized they could make money licensing movies to TV and creating and producing new forms of programming specifically for the small screen--a business that is often more lucrative than making movies.

The introduction of DVD followed a very different pattern, however.

Early proponents of the new format, particularly Warner Home Video, believed that the studios' video rental business was ultimately threatened by newer digital technology. They felt that to preserve a prerecorded video business, they needed a format that could compete with other digital-quality formats and had cost characteristics that would allow far lower retail prices for movies.

That led them to the optical disc format we have today.

Yet for all that calculation, DVD's impact on studio economics is proving just as radical as TV and the VCR--and just as unpredictable.

Although lower DVD prices are certainly influencing the rental market--in particular by undercutting the traditional price-protected rental window--the effect may turn out to cut both ways.

A lower wholesale price, coupled with the popularity of used DVDs, is allowing nimble rental dealers to compete effectively even without a protected window, in turn putting pressure on the very sell-through business DVD was designed to promote.

As Blockbuster CEO John Antioco said during a recent interview with VB, "I think Blockbuster is very capable of competing in the world where the consumer has a choice between buying and renting."

In case anyone in Hollywood didn't get the point, Blockbuster recently took out a full-page ad in The Los Angeles Times to advertise a new promotion around the film Training Day. "Rent it, Like it, Buy it," the ad says, offering to sell anyone with a rental receipt for the title a used copy for $9.99.

It's probably no coincidence that Training Day is a Warner title--the studio that has been most aggressive in trying to collapse the rental window.

With a $4 rental price, that's $14 out of a customer who rents and then buys the title. With a wholesale price about $17, Blockbuster needs to squeeze just one extra rental from that copy to cover its cost, something it can achieve within days of the title's release.

In a recent speech at the Wharton School of Business (as reported on Wharton's Web site), Warner president Warren Lieberfarb acknowledged that "Blockbuster is fighting for its survival by selling used tapes and disks at prices lower than Warner video's new movie DVDs at Wal-Mart ... We're playing a game of chicken."

Who ultimately wins that game will depend greatly on how well used-DVD prices hold up over time. At $9.99, things look pretty good for Blockbuster. But if Wal-Mart and other mass merchants push down the price of new DVDs, $9.99 could turn out to be the high-water mark for used DVDs.

Another unexpected effect of Blockbuster's enthusiastic embrace of the DVD pricing model may be to speed the day of VHS' reckoning.

As Antioco also noted in his interview, the protected rental window today really exists only for low box-office titles on VHS. And given the lower margins Blockbuster enjoys on rental-priced product, his enthusiasm for buying those titles is clearly waning, even under revenue sharing.

"My margins are going to have to go up on VHS if I'm going to do a VHS revenue-sharing deal going forward," he told VB.

When the business becomes purely a margin game for the studios, the higher cost associated with manufacturing VHS cassettes compared with DVDs is going to get harder to justify.


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