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4.7.1 Online DVD rental revenues

226. Subscription DVD rent-by-post, also known as ‘rentmail’, was pioneered by Netfl ix in the US in 1997. This sector is now fl ourishing in the UK, with the rental Offl ine DVD rental – Share of gross revenue Figure 77:

Source: Screen Digest analysis of BVA/TNS data

Rentailers (66%)

Wholesalers (0%) Studios (19) VAT (15%)

Total £272m (100%)

Offl ine DVD rental - Store count Figure 78: 1990 1991 1992 1993 1994 1995 1996 1997 Rental stores 9,000 7,800 7,600 6,500 5,673 5,200 4,860 4,500 1998 1999 2000 2001 2002 2003 2004 2005 Rental stores 4,175 3,900 3,750 3,700 3,485 3,307 3,157 3,077 Source: TNS

Offl ine DVD retail - Market share by rentailer Figure 79:

Retailer Share of offl ine DVD retail (%) Share of total DVD retail (%)

Blockbuster 48 36

Global 5 4

Choices 11 8

Independent rental specialists 15 12

Other video chains 3 3

Convenience store 6 5

Newsagent 2 1

Public Library 9 7

Other offl ine 1 1

Total offl ine 100 76

Notes: 1. Based on 2006 transactions for all DVD Source: TNS

4.7.3 Online rental environment

230. The principal costs involved in running an online video rental business are acquiring inventory and postage.

Acquiring inventory

231. Like their offl ine counterparts, online rentailers also have to buy new titles on a regular basis. However, unlike offl ine rentailers their stock acquisition is not limited to the traditional profi le of a rental title (i.e. movies). One of the features of subscription rental (which is an exclusively online domain in the UK at the time of writing) is that consumers rent a much broader range of titles, including not only catalogue movies, but also TV DVD, children’s, sports and documentaries.

232. Thus, even the UK’s leading online rental operators buy far fewer new titles designated ‘for rental’ than a rental chain generating a similar number of rental transactions would. On the other hand, however, they also have to buy copies of many of the numerous ‘for retail’ titles that are released in the UK each month. In the US, Netfl ix has claimed that 98 per cent of its inventory is rented every month, meaning that even if an online operator buys some these titles on a ‘just in time’ basis (i.e., only acquiring them when they know there is customer demand), it cannot get away with claiming titles which it does not have.

233. Our model assumes that although the online rental sector generated 28m transactions in 2006, 75 per cent of these (21m) were feature fi lms and new releases accounted for 25 per cent of fi lm rentals. The proportion of new releases purchased and thus available for rental varies signifi cantly between companies. Our research indicates Blockbuster buys in a greater proportion of new release rental titles than LoveFilm. 234. It is our understanding that no revenue sharing deals have offi cially been struck between studios and online rental operators (for more information see Revenue Sharing in section 4.6.1 Rental environment). Our research indicates that in 2006 online rental operators in the UK spent £3m on buying premium priced rental DVDs. In addition, we believe they spent £1m on buying retail priced DVDs for rental. It should be noted that we have assumed that the online operators Blockbuster, accounted for £37m of revenues,

giving them a combined market share of 86 per cent.

229. According to our analysis, studios share of gross revenues was around eight per cent, with retailers securing just over half. The ancillary cost of postage represented over a quarter of gross revenues.

Offl ine DVD rental - Blockbuster in the value chain Figure 80:

Source: Screen Digest analysis of BVA/TNS data

Studios and movie catalogues £29m Studios Blockbuster £125m Retailers Consumers £147m Consumers _VAT £22m

Offl ine DVD rental - Choices in the value chain Figure 81:

Source: Screen Digest analysis of BVA/TNS data

Studios and movie catalogues £5m Studios Choices £24m Retailers Consumers £28m Consumers VAT £4m

Offl ine DVD rental - Global in the value chain Figure 82:

Source: Screen Digest analysis of BVA/TNS data

Studios and movie catalogues £2m Studios Global £9m Retailers Consumers £11m Consumers VAT £2m

4.7.4 Principal Providers

237. Whilst the traditional offl ine rental market has showed little or no growth in recent years, the UK has seen an explosion in the number of online rental operators. The fi rst online rental service was launched in the UK in 1999 by MovieTrak, but it was not until mid 2001 that the fi rst UK website (in-movies. co.uk) began offering a subscription model similar to the one which had already proved so successful for Netfl ix in the US. By Q2 2004 over 20 companies, both Internet start-ups and online divisions of existing brick-and- mortar chains were competing in the crowded UK online rental sector. The inevitable process of consolidation began in late 2003 and by the end of 2006 two services had emerged as the sector’s key players.

LoveFilm

238. LoveFilm launched in May 2002 under the name DVDs On Tap. It merged with Video Island - owner of rival service ScreenSelect - in Q1 2006. Both partners hold an equal share in the deal which has given the combined group more than 400,000 subscribers and a market share of 75 per cent based on 2006 data. The move was designed to consolidate the companies’ position in the online DVD rental sector, to accelerate profi ts, and also expansion through European territories. LoveFilm has already established services in the Scandinavian market, with operations in Sweden, Denmark and Norway. 239. The merged company, which opted to retain the LoveFilm brand, holds around 70,000 different titles and a stock of 1.2m DVDs and video games. Combined, the two companies portfolios include AOL, CD Wow, Channel 4, Dixons Store Group, easyGroup, Guardian Newspapers, ITV, MSN, News International, Odeon, Sainsbury, Tesco and Vue cinemas, some of whom offer a fully white-labelled service. The new investor base for the group will include Arts Alliance Media (AAM), the majority shareholder in LoveFilm, and Video Island’s fi nancial backers Benchmark Capital, Index Ventures, Cazenove Private Equity and European Venture

Partners. In November 2005 LoveFilm launched a movie downloading service (see LoveFilm profi le in Internet-based rental and retail section) alongside its DVD and games rentmail offerings as part of its bid to position itself as a one-stop-shop for entertainment. identifi ed in this report had cleared any such

rentals with the rightsholders concerned.

Postage

235. All online rental offers include ‘free’ postage and packing to the consumer, meaning that these costs must be absorbed by the company. Standard UK fi rst class postage (which is suffi cient for a single DVD) costs 32 pence. As regular users of the service, the online rental companies benefi t from business rates, resulting in total postage costs per transaction (outward and return) of around 60 pence.

236. Thus the 21m feature fi lm rental transactions made through online operators in 2006 generated further costs of £13m in postage, reducing the net revenues of this sector to just over £30m.

Online DVD rental – Share of gross revenue Figure 83:

Source: Screen Digest analysis of BVA/TNS data

Rentailers (53%)

Postal charges (25%) Studios (8%) VAT (14%)

Total £50m (100%)

Online DVD rental – Cash Flow Chain (2006) Figure 84:

Source: Screen Digest analysis of BVA/TNS data

Consumers £50m VAT £7m Others £6m Blockbuster £6m LoveFilm £31m Postal Charges £13m DVD production costs £2m Studios Rentailers Consumers

Studios and movie catalogues £4m

unique selling point (USP). The same would be true in the UK if it opted to launch a local service.

4.8 DVD rental - Market-specifi c