What's next for the home video market?

Commentary: DVD's decline is spurring new business models

Oh DVD, you used to be so big. You arrived in 1997, with your roots in the optical videodisc system, DiscoVision, first developed by the former corporate parent of Universal Studios, MCA. In no time you bested VHS, which itself had not only transformed the movie business by providing both a new revenue stream and a convenient way to watch movies at home whenever people wanted, wearing whatever, but had also created an entirely new business: the video store.

You and your bonus features -- Commentary! Outtakes! Alternate endings! We never knew there was so much to "Cabin Boy"! -- eventually became more than 50% of a motion picture's revenue. And, you even had your own release day: Tuesday.

Even better, the studios got to make 80% of the revenue from your sales totally disappear from participation and guild residual statements because everybody accepted the concept of a 20% royalty. Genius. More so because the actual cost to make you was less than $1, and your wholesale price is now around $15 (though don't get all grand on us about that because your revenue is just part of the calculus of greenlighting a picture).

But then the economy tanked; your sales dropped 30% from your peak; Wal-Mart, representing over 40% of domestic DVD sales, decided it wanted a clean store and that you were cluttering it up -- not to mention that it sold you below cost anyway. And the new you, Blu-ray, which was going to cause everyone to buy the same movies all over again at a higher cost has yet to live up to expectations.

You used to be big, and it's not like the pictures have gotten smaller. Actually, they got bigger because of you. So what's next?

Inspired by the dismal economy and the drop in DVD revenue, studios are rethinking how they make talent deals -- eliminating first-dollar gross, limiting writers to one guaranteed draft and generally doing what they should have been doing years ago when DVD revenue was at its peak: trying to run their business like a business instead of a lottery. Because it's the movie business, there always needs to be the dream of a windfall in the future, and this year's entrant in the everything old is new again category, 3D, is the next best hope. But the decline in the DVD business has broader implications that are not answered by converting every movie to 3D, and in the same way that the introduction of DVD changed the face of the business, the migration away from the format is changing it again.

Although the dollar volume of DVD sales is down, when you add the sell-through numbers to rental sales, the total number of transactions demonstrate consumers' continuing love affair with watching movies at home. The success of "Alice in Wonderland," despite the well-publicized controversy of its shortened exclusive theatrical window, could show that good movies always attract people. Even though the "Alice" DVD is coming out almost before patrons get out of the multiplex parking lot, it does give hope to studio marketing executives that they can take advantage of all the theatrical ad spending since about 80% of DVD sales take place in the first four weeks of release.

Or maybe it's that there isn't an acceptable mass home-viewing alternative for 3D at the moment, and "Alice's" grosses are inflated by the 3D upcharge. Whether 3D will pick up the slack in the home entertainment market from 2D DVDs remains to be seen. This is the year for introducing 3D TVs into the home, but it will take awhile to get penetration, not to mention the issue of no single standard for glasses. (You would think by now they'd get together on this sort of thing.)

As far as converting older movies to 3D, similar to the question of converting to Blu-ray, it's not certain that the market is there. In addition to the technical issues that most of those older movies aren't good enough to convert, there are the movies themselves. Want to see "Casablanca" in 3D? It should be against the law. But Russ Meyer's "Super Vixens" in 3D? Absolutely.

What should have everyone's attention, however, isn't the technology but the delivery mechanism that people will use to get the movies into their homes. As DVD sales have fallen and a trip to the video store is less appealing, Netflix and Redbox have taken off, with VOD right around the corner. And all three have dramatic revenue implications for studios -- as well as talent and the guilds -- that love them.

For studios, the revenue-share deals on Redbox and Netflix are not particularly lucrative. Netflix tends to commoditize movies with its subscription basis, so that the consumer views it as free. Since 70% of the titles that are viewed on Netflix are catalog, which earn nothing for studios after six months of availability, it actually becomes free.

From the studio perspective, Redbox is worse because like Napster it degrades the value of the product. Consumers might have a different view of $1 rentals.

VOD may be the better alternative for consumer and studio alike. For consumers, the below-$5 price point is affordable, and how many movies are worth owning anyway? For studios, a VOD transaction is a license, affording them more control like theatrical distribution. But there are alternatives: Sony and Microsoft are talking about putting your movies in a cloud, just like Jell-O did with pudding, so that consumers can watch their movies on any of their multiple platforms. That pits them against Apple and its proprietary system, which manages 75% of the VOD market and 95% of download-to-own transactions.

But there's a catch: Although there is some lack of clarity among studios, VOD generally is treated as television distribution in profit definitions and for guild residual purposes, meaning that 100%, not 20%, of studio revenue is included in gross revenue for those purposes. As consumers migrate to in-home transactions like VOD, the financial implications are more complex than merely replacing one purchase transaction with another.

Fox and Universal recently joined Warner Bros. in signing a deal with Netflix that allows for a 28-day delay on new releases in exchange for better purchase terms. Netflix also will buy more movies to allow for more availability of streaming. But then, streaming generally is treated as a television exhibition, so now studios are back to sharing more of the proceeds. See, it's complicated and a lot messier than a house in a Nancy Meyers movie.

The issues facing the motion picture business and the economic system surrounding it are enormous and complex because nothing about the pictures is ever small. Unfortunately, planning for the future often is orphaned when the next big hit or new technology comes along. Without a comprehensive plan, though, the business is in danger of its dreams of a brilliant future being already behind it, and as Nick Carraway would note, studio executives -- so slavishly devoted to the green light -- will be thinking they are moving forward as they are borne back ceaselessly into the past.

Jeffrey Korchek, vp legal and business affairs at Mattel, worked at Universal as executive vp business and legal affairs. He is an adjunct professor at the USC School of Cinematic Arts.