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December 22, 2006

How Bad Are DVD Sales?

I don’t want to pick a fight with Jim Cramer and Doug Kass, my fellow contributors at theStreet.com's family of websites, but they are exaggerating the issues in DVD sales. The Pali report is correct in noting that consumer interest in DVDs is waning as evidenced by flat sales despite a huge increase in DVD households. But I have a few issues with the conclusions Jim and Doug are drawing from this report.

First, Circuit City and Best Buy are talking about low to mid-single digit comp store declines in this category. Just last quarter, both retailers reported positive comps for DVDs. I wouldn’t say that a low to mid-single decline "takes my breath away." Second, the development of alternative digital distribution channels for recent theatrical releases is in its very early stages and not likely the cause of the well-documented slowdown in DVD sales. Recent theatrical releases that drive DVD sales at major retailers are not available on VOD through your set top box as studios have not yet collapsed that window and show no signs of doing so. Furthermore, recent theatrical releases are only available on a very limited basis through internet downloads such as iTunes and data available on downloads indicates hundreds of thousands of units, not enough to move the needle when a single title like Cars or Pirates of the Caribbean: Dead Man's Chest is selling 15-20 million units just this quarter. And even if you think that digital downloads are about to explode, I wouldn’t bet on it. Current download speeds and the lack of an easy way to get the movies from your PC or Mac to your TV will prevent this channel from growing large any time soon. Apple's iTV product, expected in 1Q07, will be a good start but its impact will be limited for the next couple of years....

And is it really negative for the studios if iTunes or another download channel develops? I'd say not necessarily. The argument goes that that iTunes movie pricing undercuts Wal-Mart, Target, Circuit City, Best Buy and other retailers and this will hurt the studios. But downloaded movies should be cheaper. All the consumer gets from iTunes is the movie. No Director's Cuts. No Special Features. No booklet of information. Maybe most importantly, no HD download, just a low density picture much worse than current DVDs, let alone next generation DVDs like Blu-ray (that means even if you got your digital download over to your HD TV the picture would be really bad).

Consumers aren’t stupid. They will expect and deserve a lower price on digital downloads. Consequently, I see a two tier market developing for recent theatrical releases. You want it all and you want to watch on your new HDTV, head on over to Wal-Mart. On the go or addicted to your PC or Mac, go ahead and download.

Lower pricing on digital downloads is a negative: for the retailers. They lose share of a large product category and a key store traffic generator. But for the studios, this might not be a negative. Wholesale pricing might come down slightly in online channels. But lower pricing comes with lower costs for the studios which incur no manufacturing or packaging expenses. In other words, it is plausible that operating profit per unit on a digital download is no different than on a DVD bought in a store.

There is no doubt that DVD sales are no longer a driver of studio profits. But that isn’t new news. And it is far different than a collapse in operating profits from the DVD business. The end of DVD's as a growth business story broke in the summer of 2005 and is already deeply embedded in analyst estimates for the conglomerates that own the major studios. The story may be getting new legs thanks to the Pali Research report but it is neither new, nor as one-sided as Cramer and Kass suggest.

In fact, maybe if those digital distribution channels develop as fast as people think, it will set off renewed interest among consumers in building their movie libraries. Or maybe consumers will replace their favorite movie titles with HD DVDs once the format war is settled. Transitions in content delivery in the past have usually been positive for demand. Maybe it is different this time, but for now the "DVD is dying story" is more bark than bite for the major entertainment stocks.

Posted by Steve Birenberg at December 22, 2006 01:57 PM in Media