DVD kiosks like Redbox have rivals seeing red

We all know that DVDs are dying, and pretty soon people who want to watch movies at home will just stream or download them from the Internet, cable or satellite. Right?

Don't tell that to the executives at Redbox. This mouse of a company — it generated just $389 million in revenue last year — is flooding Walmart, McDonald's, 7-Eleven and other retail, supermarket and convenience store chains with vending machines that rent the latest DVDs of Hollywood blockbusters for just $1 a day.

That combination of low price and convenience has suddenly made Redbox a force with consumers — and a threat to Tinseltown studios and rental giants such as Blockbuster and Netflix, which typically charge much higher prices.

"Our (DVD) product rented at a dollar is grossly undervalued," News Corp. President Chase Carey, whose company owns the Fox studio, told analysts last week. "It's a real issue. And we're actively determining how to deal with it."

It may be too late. Following agreements with Albertson's and Kroger supermarkets, Redbox expects to end this year with 22,000 kiosks in all 48 mainland states, up 61% from the end of 2008. Company parent Coinstar says that revenue from the DVD rental operation could double to as much as $780 million.

"We calculate that 150 million people every week walk within 10 feet of one of our locations," Redbox President Mitch Lowe says. "The way we'll grow is by focusing on the customer experience. That's how we've come out of nowhere."

Success breeds competition, and Blockbuster says it will have nearly 3,000 kiosks renting and selling discs and games by the end of this year, growing to 10,000 in late 2010.

"One of our price points will be 99 cents," Blockbuster CEO James Keyes says. "But we will have a broad range of other offerings."

For now, Redbox is sticking with DVDs while it tests interest in $1-a-day Blu-ray discs.

Its machines stock as many as 700 discs, usually about 200 different titles. Consumers use a credit or debit card to rent DVDs — no membership required — and can return them to any Redbox kiosk. The machines read bar codes on each disc to register what's gone out and come back.

Renters hold on to discs as long as they want; after 25 days (and a total charge of $25) they can keep the DVD. About 10% do so.

The machines constantly communicate with Redbox, primarily via cellphone transmissions. People can go to the company's website to see what's in stock at different kiosks, and reserve a movie at a particular machine.

But kiosks are taking off mostly because credit card companies have improved their ability to securely handle massive numbers of transactions.

"We're among the top 10 credit card processors in the country," Lowe says. "On an average Friday and Saturday, in the evening, we process 70 to 80 transactions per second, which is around where Amazon has stated its peak Christmastime sales volume was."

Low-price model

Redbox pays about $18 for a DVD and rents it about 15 times at an average of $2 per transaction. The company sells half of the used DVDs back to wholesalers for as much as $4 per disc, and sells about 3% directly to consumers for about $7. It destroys most of the rest.

That low-price model suits Redbox just fine, but not so much the Hollywood studios, which count on home video rentals and sales for about half of their revenue.

If consumers figure it's only worth $1 to see a movie at home — instead of the $4.50 or so charged by rental chains and video on demand — then it could "cripple the economics of today's movie business," Pali Research analyst Richard Greenfield said in a recent note.

Universal was first to fight back: Last year it insisted that Redbox not rent the studio's new DVDs until 45 days after they're available elsewhere. When Redbox refused, Universal told the kiosk firm's top wholesalers to cut off its supply of the studio's DVDs.

Redbox asked the U.S. District Court in Delaware to find Universal guilty of violating antitrust and copyright laws. Redbox still offers Universal flicks, often after buying its DVDs at retail.

Universal declined to comment for this story, but told the court that the case simply involves Redbox's desire to get Universal's DVDs "on terms that are at odds with the terms on which Universal wants to sell them."

Fox last week began asking wholesalers to wait 30 days before selling its new releases to Redbox.

Hollywood is divided, though: Disney is supplying new releases. Last month Sony agreed to do the same — on DVD, not Blu-ray — for five years; Redbox will destroy used discs when it's through renting. "It's difficult to fight against a consumer trend like this," Sony Pictures Home Entertainment President David Bishop says.

On Tuesday Lionsgate also reached a five-year deal with Redbox.

Blockbuster, says it wouldn't mind if stores got DVDs before they hit the kiosks. That way new discs bought for the stores would "move from the shelves to the vending channel, and then we'd have an advantage with significantly (lower) cost of goods," Keyes says.

But Redbox says that its kiosks with their $1-a-day discs have changed the entire video-rental game. "This has put the power of the decision in the customer's hands." Lowe says.