Susan Easton: Movie giant's fall fable for net age

Back in 2000, buying a video rental store probably seemed like a smart, long-term investment.

VHS cassettes were on the way out but the industry's future looked bright with the emergence of DVDs, the fancy new technology that offered sharper pictures, no rewinds, and loads of geeky extras like director commentaries and music videos. You could be forgiven for thinking you were getting in early on a hot new trend.

But fast-forward to 2010, and bricks-and mortar video stores suddenly seem old and tired - destined to go the same way as record shops and spacies parlours. DVDs are still a popular format, but pay movie channels and mail order delivery are slowly taking over from a visit to the video store.

It's not hard to see why. Who wants to go through the hassle of driving into town when you can browse movies online and have them delivered directly to your TV or mailbox? Especially in the depths of winter, or any time of year in Wellington.

The dwindling shelf life of video stores has hit the headlines recently after a couple of high profile bankruptcies in the US.

Movie Gallery, previously the country's No 2 chain, went into liquidation earlier this year. Then last month came the collapse of Blockbuster, the undisputed heavyweight champ of the movie rental world.

After posting losses for much of the last decade, the 6500-store behemoth finally threw in the towel, beaten into submission by faster, leaner competitors. It won't be the end of Blockbuster, but widespread store closures are in the pipeline, and the once-mighty empire will wind up a shadow of its former self.

Blockbuster's failure serves as a reminder of how quickly companies need to adapt in the internet age. Investors have to be nimble, too, because the changes don't just apply to technology stocks.

They're affecting companies involved in retail, media, telecommunications, banking, even health care. Blockbuster is just the latest cautionary tale. Back in 2002, investors thought they were paying $30 a share for a robust retail story with a market-leading position. Today, those shares are trading at less than a cent.

While market forces worked against Blockbuster, management has to shoulder a lot of the blame. They were too slow to react to the rise of online ordering and mail delivery, as practiced by Netflix since 1999.

By the time Blockbuster got around to introducing its own online service in 2004, it was already playing catch-up, forced to offer ridiculous discounts to win back customers.

And it wasn't just the Netflix model that caught Blockbuster napping. In 2004, Redbox announced its arrival by plonking 140 self-service kiosks at McDonald's restaurants in Denver. The vending machines hold up to 600 DVDs and customers pay by credit card, incurring charges if the DVDs are not returned on time.

The big advantage of the concept is cost. Given its limited overheads, Redbox is able to charge $1 per rental, a price traditional DVD stores can't hope to match. In less than six years, the number of vending machines in the US has grown to more than 22,000, grabbing an estimated 20 to 25 per cent of the market.

Similar trends are happening here, with the usual five-year lag. In true Kiwi style, a number of local entrepreneurs jumped on the Netflix business model back in 2004, before the Americans could be bothered locating New Zealand on a map. They've all since merged and Fatso (now half-owned by Sky TV) has emerged as the Kiwi Netflix, albeit with less penetration.

By the time the mail-order model catches on in New Zealand, the industry will have moved on again.

In three years' time, we might well ask - who wants to brave a cold trip to the mailbox when you can get exactly the movie you want, when you want, downloaded directly on to your computer or TV? On-demand technology is already here, and when broadband speeds improve and the available content begins to resemble what's on offer at a large DVD store or Netflix database, there will be no looking back.

In the US, Netflix is already offering mail-order subscribers the opportunity to watch a selection of its content via video streaming. At the same time, it's buddying up with hardware platforms like PlayStation and Apple TV to deliver its content, not to mention signing up online streaming rights with major film and TV companies.

In other words, rather than resting on its laurels, Netflix is doing everything possible to ensure it remains relevant in the digital age. Blockbuster's management should take note.

Will there still be a place for bricks-and-mortar video stores in this new, high-tech environment? Probably. There will always be customers who prefer to browse actual shelves and take recommendations from people they can eyeball.

But these stores are likely to be niche operations, catering to a selective clientele. Because for the popcorn-munching masses who just want to watch Transformers IV as quickly and cheaply as possible, returning a DVD to the local video store will soon seem as backward as calling a landline.

* Susan Easton is an investment analyst with Gareth Morgan Investments.