Studios see red as DVD rental kiosks flourish

The hottest thing in movie rentals is as old as the Coke machine -- and just as red.

Redbox movie kiosks are popping up by the thousands in supermarkets, drugstores, restaurants and convenience stores around the country. The kiosks stock DVDs that rent for $1 a day, a remainder-bin price that is less than a cup of coffee at Starbucks.

For all the talk about the Internet, Wi-Fi and cellphones becoming the new gateways to watch movies and wiping out the corner Blockbuster, a ubiquitous vending machine the size of a refrigerator is becoming a growing concern to Hollywood.

Consumers are pulling DVDs out of the Redbox kiosks in record numbers, undermining longtime economics that have propped up the movie business -- and in the process triggered a backlash from a major studio that sought to cut off Redbox’s supply of hot new DVDs.

“We have grown at a phenomenal pace over the last six years, and that growth is continuing, even in the midst of the recession,” said Gregg Kaplan, chief executive of Oakbrook Terrace, Ill.-based Redbox Automated Retail. “We’re not seeing anything that’s slowing it down.”

Redbox operates nearly 12,900 kiosks throughout the U.S. -- four times as many locations as Blockbuster Inc. -- and plans to introduce 7,100 more by the end of the year. Each machine holds as many as 700 DVDs and 200 movie titles.

Consumers rent a DVD from the machine using their credit or debit cards, which enables Redbox to charge an additional day’s rental if the DVD is not returned within a 24-hour period. A typical kiosk can earn significant coin: about $50,000 annually in revenue per machine in operation after three years.

Blockbuster could be getting green with envy at Redbox. The Dallas-based movie rental giant started rolling out its own DVD-vending kiosks last summer and is testing dollar-a-night rentals at 600 stores, with plans to roll out the new pricing to 4,000 outlets.

“We have been watching very carefully as they have progressed,” Blockbuster Chief Executive Jim Keyes said. “We think it is very consistent with what Blockbuster does, which is to provide convenient access” to home entertainment.

The discount DVD rental business worries Hollywood movie studios because of fears that it is undercutting DVD sales, which dropped 13% in the fourth quarter and were projected to fall at least 6% more in the first quarter, according to analysts.

DVD sales historically have been how the studios earn a profit on movies, because ticket sales are barely enough to offset production and marketing costs. Some studios believe that consumers will forgo buying DVDs if they have a cheap option to rent movies.

“You could make a bit of an argument that rental is cannibalizing [DVD purchases] in 2008, especially in a recession year, where everyone is watching their nickels,” said Tom Adams, a video industry analyst.

The spread of Redbox’s kiosks, coming as DVD sales started to decline, has triggered alarms within Universal Studios. Last year it sought to withhold DVDs from Redbox until 45 days after release to prevent competition with sales. When Redbox rejected the deal, Universal ordered wholesalers to cut off supplies. Redbox then sued Universal, alleging restraint of trade.

Universal has responded in court filings that it has the right to direct wholesalers to conform with the studio’s marketing plans and determine when a motion picture ought to be made available to the public.

In the early part of the decade, when DVD sales were booming, Hollywood paid little attention to Redbox. At the time, the kiosks barely registered a blip on the screen. The company was owned by fast-food giant McDonald’s Corp., which saw in the fragmented vending machine industry an opportunity to bring the same consolidation and conformity it brought to burgers, fries and shakes.

Market testing by McDonald’s in 2004 showed that consumers were willing to use the vending machines, which crossed the look of a London phone booth with the retro functionality of a cafeteria automat, as a cheap and quick alternative to the video store. The kiosks caught on, especially in supermarkets, where they catch customers’ eyes as they push their grocery carts through the checkout counters.

The combination of errands to fill the cupboard and rent movies, as well as the consistent flow of customers, turned out to be advantageous: By the end of 2005, Redbox reported that it was renting more than a million DVDs a month out of 1,200 locations.

“It’s a regularity of traffic, and the biggest single place people are going after the supermarket is to their homes,” Redbox’s Kaplan said. “Consumers tend not to rent DVDs when they’re not going home.”

McDonald’s, however, decided that vending machines were not part of its core fast-food business. It set up Redbox as a separate company and ultimately sold control of Redbox to Bellevue, Wash.-based Coinstar Inc., an operator of coin-counting machines, coin-operated games and kiddie rides that crowd the exit aisles of supermarkets (last month, Coinstar announced that it would acquire full interest).

Coinstar’s strong relationships with supermarket operators soon had the Redbox kiosks springing up in chains such as Albertsons, Walgreens and even Wal-Mart, which accounts for 40% of DVD sales.

Coinstar does not disclose earnings for Redbox. But its automated DVD rental business, which includes the smaller DVDXpress kiosk operation, reported operating income of $73 million on revenue of $388.5 million in 2008. The company expects sales to nearly double this year to between $690 million and $750 million.

Video industry analyst Adams estimates that the kiosk rental market, which totaled $519 million last year, will reach $1.4 billion in five years -- or about one-fourth of Blockbuster’s 2008 revenue.

“You could view that as directly competitive” with Blockbuster, Adams said. “It’s a cheaper option, and during a recession people embrace it.”

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