Netflix rises as studios' DVD money plunges

Not long ago, ambitious young executives at the six major Hollywood film studios maneuvered to get into the home entertainment divisions.

Nowadays, getting assigned to home entertainment is like being sent to the Eastern front. Better to work in theatrical distribution, international, or maybe studio facilities. Recently, I spoke with an executive from one of the big studios who, while discussing the challenges of working in the film industry, noted there was one silver lining: "At least I don't work in home entertainment."

The studios' home-entertainment divisions typically oversee sales of DVDs and Blu-ray discs as well as Internet distribution. But the DVD has long been synonymous with these units for the simple reason that the discs account for the vast majority of revenues. This week, Sony, Time Warner, Viacom and News Corp., reported earnings and their film divisions continue to see falling DVD sales.

For the quarter ended December 31, Paramount Pictures saw a 44 percent decline in home video revenue from the same period a year ago, according to Viacom, Paramount's parent company (don't people give DVDs as holiday gifts anymore?).

Bad films or dying format?
Time Warner, which owns Warner Bros. Pictures, generated $923 million in revenue from home video and electronic delivery of feature films. That was a 23.5 percent tumble from the $1.23 billion made during the prior-year quarter. Sony and News Corp., which operates 20th Century Fox, don't break out their home video numbers, but they both signaled that DVD sales were ailing. Sony reported that Sony Pictures suffered a 20 percent overall decline in "sales and operating revenue" in the quarter partly due to "lower home entertainment revenues from catalog product."

For two decades, DVDs and before it, VHS tapes, were a huge source of profit for the studios. DVD sales outpaced box office sales between 2002 and 2009. Barry McCarthy, Netflix's former chief financial officer, noted a couple years ago that the DVD was the most successful consumer product launch in history measured by penetration into U.S. households. He said five years after debuting, DVDs could be found in half of all U.S. households. But the garden years appear to be over, as consumers continue to show less and less interest in physical media and turn to the Web for entertainment.

In their earnings report, the studios blamed the poor quarterly performances in home entertainment on the high number of hit films they had during the prior year. The way the studios tell it, they produced a higher number of popular films in 2009 than they did in 2010 and that resulted in lower DVD sales. This explanation, however, doesn't jibe with box-office figures.

Overall ticket sales in 2010 were $10.5 billion, just shy of the record-setting $10.7 billion generated in 2009, according to Boxoffice.com, an online service that tracks theatrical revenue. There were plenty of popular films last year. What this suggests is that in a down economy, people continue to find enough money to go to the movies. What they're apparently cutting back on are DVDs.

Why own movies?
Now, contrast the studios' dismal quarterly numbers with Netflix's performance during the same period. The video-rental service, which mails DVDs to subscribers as well as streams films and TV shows over the Web, added 3 million subscribers in the quarter--largely on the growing popularity of its streaming service, the company said.

It's not an apples-to-apples comparison, but it shows significant numbers of consumers are moving to Netflix, a service that all but eliminates the need to own movies.

Netflix now has 20 million total subscribers, a 60 percent year-over-year increase. If Hollywood wants to know where the DVD money went, this would be a good place to start looking. It shouldn't be hard to figure out that Netflix is thriving because it provides consumers with what they want: convenience, control, and a good price. For $7.99 a month, a Netflix subscriber gets access to all of the service's streaming content. That's just a better deal, when a single DVD often costs twice that amount.

That Netflix offers an alternative to owning movies or paying for cable TV, may explain why Time Warner CEO Jeff Bewkes has criticized Netflix so much lately. Another reason could be that at this early stage, Web-video distribution doesn't appear to be the cash cow that DVD was in its heyday.

The good news is that not everybody at the studios sees Netflix and Web distribution as a threat. A group calling itself DECE--made up of film studios, software, and hardware makers and almost everybody else connected to film and TV--is trying to create a set of standards and specifications designed to make approved digital content playable on a wide range of certified devices. The standards are called UltraViolet.

Supporters say this could help mainstream consumers make the jump to streaming distribution. Critics say this is an attempt to wrest control of digital distribution away from users. Regardless of whether UltraViolet works, it's a sign that some at the studios see the end of the DVD coming and are preparing for that day.