DVDXpress All You Can Eat

Every now and then a business model comes out that is so powerful and yet so obvious that I can’t help but think, how did I not think of that first? This was my response when I first found out about Netflix. The idea of unlimited rentals without any late fees seemed like such a no brainer that it still amazes me that BMG wasn’t doing this during the 1980’s, let alone that Netflix was able to get a patent on the business idea. Nonetheless, Netflix was the first one to come up with the idea and Reed Hastings has been able to build an impressive business around it.

With Blockbuster, Greencine & a host of other internet DVD companies jumping on the internet bandwagon, it’s no surprise that this business has changed the video store forever. These business ideas are rare, but when they come around they are truly special and they create quite a bit of turmoil for established businesses.

Over the last few years, I’ve taken a lot of interest in the DVD kiosk and having watched as the technology has gone from an experimental stage to one of the hottest growth areas in the DVD market today, I can’t help but think that we are on the precipice of one of the greatest developments in DVD rental industry to date. While the DVD kiosk business model is revolutionary by it’s own right, it hasn’t presented a challenge to Netflix’s business model because of the limited DVD availablity and because the technology hasn’t hit the mainstream just yet. Nonetheless venture capitalists have taken notice of the possibilities and we’ve seen strong demand for kiosk technology, especially by the grocery store chains and it’s only a matter of time before the DVD kiosk begins to replace the stand alone video store.

In the past, I’ve hypothesized that the DVD rental market would fragment into two pieces. The first would be people like myself who really want to watch unlimited longtail archived content and who were willing to give up access to new releases and spur of the moment rentals, in exchange for the luxury of not having to return a DVD to the video store. The second piece of this market will go to the video stores and more importantly the DVD kiosks which can provide consumers with instant gratification, if they don’t mind the limited selection and having to make a second trip back to return the DVD. Because of the vast differences between the rental styles, I didn’t feel like Netflix really had much to worry about from the DVD kiosks, but overnight everything has changed.

Yesterday, DVDXpress announced a new business model that I believe will send shockwaves through the DVD rental industry. Their business model is to allow consumers to rent an unlimited number of DVDs from any of their kiosks for a small monthly fee of only $12.99.

What makes this business approach so unique is that DVDXpress has figured out a way to combine the advantages of the fixed cost structure that the video store has, without the high variable costs that Netflix has to deal with. Because Blockbuster has certain expenses they have to pay no matter what, they must meet these fixed costs or else their business will suffer. These costs involve debt payments, lease obligations & salaries. The advantage to Blockbuster’s business model is that if they meet these costs, each additional rental is practically pure profit for the company. Compare this to Netflix, who must paying the post office for every DVD that you watch. While Netflix doesn’t have to worry about staffing 8,500 locations, they do pay high variable costs if their customers want to rent more DVDs. Because of this, you have an industry where Blockbuster wants you to rent as many DVDs as possible and where Netflix would prefer that you rent as few DVDs as necessary.

DVDExpress’ business plan is so powerful because their fixed costs are relatively low compared to Blockbusters and yet their transaction costs are almost non-existent compared to what Netflix has to pay to ship you a DVD. This means that if someone rents 30 DVDs in a month, it doesn’t necessarily cost them any more then if someone only rents 1 DVD a month. Compare this to Netflix’s strategy where they are forced to throttle their customers in order to maintain the profit margins. Considering that DVD kiosks cost anywhere between $20,000 – $25,000 to buy, one would need to rent 10 DVDS a day at $2.50 just for their initial investment to pay off in 2.5 years. With a $1 a day kiosk price war currently in place, this isn’t an easy task to achieve and even at some of the heaviest trafficked areas it can take at least a year to get to this level. On the other hand, if DVDExpress gets just 75 – 100 subscribers to adopt the monthly $12.99 pricing, then a kiosk could easily pay itself off after 2.5 years without having to place the machine in a heavy traffic area. Once the machine is paid off, the DVD kiosk essentially becomes a cash cow.

There is also a benefit to retailers to partner with DVD kiosk companies employing this strategy because it gives the consumer a reason to come back to the retail location again and again. It’s no secret that McDonald’s launched Redbox as a loss leader in order to drive more traffic to their store, but once a consumer returns a DVD, what incentive do they have to return to that McDonalds again? With a monthly subscription fee in place, consumers not only don’t have to stress out about having to return their DVDs, but psychologically they they are encouraged to come back to the business because they don’t feel like it will cost them anything to rent another DVD.

DVDExpress has clearly come up with a powerful business model that combines the upside benefits of Blockbuster’s fixed cost structure without the downside variable costs associated with Netflix’s business model. This innovation is so brillant that despite consumers being limited to only 200 unique DVDs at any given time, I think it could change the rental industry dramatically. Hopefully, DVDExpress has already moved to patent the business idea because as soon Redbox, TNR Entertainment, DVDPlay, DVD Station, and Moviebank get wind of this, they will undoubtably begin considering their own DVD subscription plans.