Last week, Greg Meyer fired the first shot in a proxy war by submitting paperwork to have his name considered for a position on Blockbuster’s board of directors. To win, he’ll need to take on board of director incumbent, James Crystal. In the proxy filing, Meyer makes a strong case that he is the more qualified candidate for the position.

-In 2001 Meyer started a DVD kiosk business at a time when most thought the idea was crazy. Eventually, DVDXpress was sold to Coinstar and later merged with Redbox. Mr. Crystal on the other hand has spent his career running an insurance company and doesn’t have any DVD industry experience.

-Over the last year, Meyer has put his own money on the line by purchasing over 600,000 Blockbuster shares on the open market, Crystal on the other hand has less than $50,000 worth of Blockbuster’s stock and only because it was given to him for serving on the board of directors.

-While Crystal’s full time job is his insurance business, he also serves on 7 other boards for various insurance companies. Meyer’s only other board position is with a non-profit that uses movies to help reach young kids.

-Perhaps most damaging of all though, is the related transaction between Mr. Crystal and Blockbuster. Last October, Blockbuster made Frank Crystal & Company their exclusive insurance broker for the company. At the same time, Mr. Crystal, who sits on the compensation committee, was helping to award over $1.5 million in bonuses to Blockbuster executives in a year where Blockbuster lost over a half a billion dollars. Given that Blockbuster CEO James Keyes was awarded $400,000 of that bonus, perhaps it isn’t all that surprising to see him come out against Meyer’s nomination.

In a press release, Keyes rejected the idea of adding Meyer to the board and wrote,

“While we have an appreciation for Mr. Gregory Meyer’s investment and interest in the company, those are not sufficient reasons for his candidacy for the board. We are disappointed Mr. Meyer is pursuing a costly and disruptive proxy contest. A proxy contest can only serve as a distraction to the company when attention and resources would be better used in creating value for stakeholders by implementing our strategic plan. We assure all of our constituencies that we remain committed, as always, to doing what is right for our shareholders, debt holders, employees, and customers,”

Distraction or not, it’s understandable that Blockbuster’s shareholders would be disappointed in the current board of directors. Since bringing on Keyes, Blockbuster has seen their stock fall from $4.46 to $0.29 per share. During that time, they’ve seen Netflix and Redbox take market share from them, while they were concentrating on trying to figure out a way to save Circuit City from bankruptcy. Instead of focusing on offering an all you can eat streaming service, Blockbuster spent their operating income on redesigning their stores. Meanwhile, they’ve continued to lose the confidence of both the stock and bond market.

Given that there aren’t many people who’d be willing to run into a burning building in order to save a video store, I reached out to Mr. Meyers to help better understand what he hopes to accomplish with his proxy run. Below is a transcript from our interview.

Davis: I guess the biggest question on my mind is that with Blockbuster clearly hurting pretty bad right now, why you would even want to get involved with the company. You’ve already proven that you can build a DVD business from scratch, what is it about the challenge of turning the company around that appeals to you, instead of using your time and capital to create another new business?

Meyer: When our team was building the DVDXpress business early on, we spent years struggling to make customers aware of the fact that it was possible to rent DVDs from a kiosk and encouraging them to do so. Blockbuster was such a dominant force at the time that we felt like we were constantly swimming upstream against this 900lb gorilla.

Fast forward to today and the tables have turned so that many people say ‘Why would I ever go to Blockbuster?’ I think the pendulum has swung too far and believe there is an enormous amount of intrinsic value within Blockbuster that can be realized with proper guidance and forward-thinking strategic insight. Love ‘em or hate ‘em, everyone knows that Blockbuster means movies, and having such widespread brand awareness is extremely valuable.

Davis: Having served on the front lines of the bond market, what insights does this give you into how the banks and hedge funds might be thinking about Blockbuster’s debt right now? Specifically, what sorts of things do you think that they’d like to see in order to be amenable to restructuring overtures?

Meyer: The perception in the market is that Blockbuster’s subordinated notes will be equitized at the expense of shareholders. I believe there are some intelligent steps that management can take to avoid this outcome, which would obviously be advantageous for shareholders- and I have recently apprised them of one such structure. The Company and its legal and financial advisors need to be thinking about creative solutions to bring the company back to health and not take the easy way out by converting sub debt
to equity unnecessarily. My impression is that the Company and its advisors are looking at this as a zero sum game instead of trying to figure out how to creatively increase the size of the pie for all constituents, which I think is doable. That’s why I think it’s so important to have at least one shareholder advocate on the board.

Davis: You also mentioned in your filing that you’d like to pursue a solution that results in the lowest possible dilution, if any, of shareholders. Given the burden of having to service almost a billion dollars worth of debt, can Blockbuster be competitive in an industry whose competition is cutthroat right now? Can you share any thoughts on your rescue plan for Blockbuster and what it might take to save the company?

Meyer: Blockbuster has some incredibly valuable assets and competitive advantages. In addition to huge brand awareness, the Company has very strong relationships with the Hollywood studios. These studio relationships have become more apparent in the last few months with the Warner, Fox, and Sony supply deals providing Blockbuster with day-and-date availability of new release titles vs. the 28-day delay for other channels. This is a huge advantage relative to Netflix and kiosks competitors, and it’s one that Blockbuster has never had in the past. I think the company has done a reasonable job of communicating this advantage to customers with the recent release of ‘The Blindside’ and ‘Sherlock Holmes’.

For now, having closed many of its underperforming stores already and amid a significant reduction in overall brick-and-mortar industry capacity, Blockbuster’s physical stores represent a true asset if managed properly that can generate significant cash flow for years to come and act as a bridge to its various future distribution channels rather than an impediment.

Davis: Blockbuster released a press release urging shareholders to reject your advances, saying that they were disappointed that you were pursuing a “costly and disruptive proxy contest” at a time when their efforts should be focused on executing their existing turnaround plan. Do you feel that it’s appropriate for Blockbuster management to publicly respond this way and do you have any concerns that your actions could have any negative consequences by trying to shake up the status quo?

Meyer: The reality is that Blockbuster’s management is making the decision to perpetuate a proxy contest. I find it unconscionable that management would be willing to waste shareholders money to fight a full blown proxy contest to keep a qualified, industry relevant and highly motivated individual off the Board. If James W. Crystal is as valuable as James W. Keyes suggests then I would be happy to serve constructively with him on the board. This does not have to be mutually exclusive. Keep in mind the size of the board has shrunk from 9 to 7 over the past few months due to several departures, so having both of us as directors would actually return the board to a more normal size. But this is a decision that Jim Keyes and the Board has to make as it is out of my hands.

Davis: Beyond the finance side of the equation, is there anything that you feel Blockbuster should be doing to make their product more relevant to consumers?

Meyer: Yes, I think the value proposition to customers can be significantly improved. Look at the smart things that smaller brick-and-mortar video competitors like Family Video (rental) and MovieStop (retail) are doing. These companies have been growing rapidly over the past several years as they’ve figured out how to remain relevant with consumers despite growing competition from Netflix and the kiosk operators. These companies offer a variety of real services to their customers. As one small example, both of these chains offer a ‘Notification Service’ by which they will call or email their customers when a movie or game becomes available for rental or sale, either new or used. This builds goodwill and drives customer traffic. Sometimes a lot of small improvements at the margin add up to a much better experience.

And of course there are many innovative steps the company can take to serve customers digitally, some of which they’ve started to take with Blockbuster On Demand. The combination of near ubiquitous brand awareness and strong studio relationships has the potential to make Blockbuster a dominant player in digital delivery going forward, but this path needs to be navigated intelligently to ensure success.

Davis: Finally, Carl Ichan previously spent a lot of time and money trying to win board seats and concessions from Blockbuster management. While he ultimately won, his actions haven’t seemed to help the company all that much. Even if you were to win a seat, do you think that you’d have enough influence to create the kind of change that Blockbuster needs in order to save their business?

Meyer: All I can ask for is the opportunity to have my informed opinions heard at the board level and hope that the other directors would act in a rational and objective manner in the best interests of the shareholders.

Since I’m not a Blockbuster shareholder, my vote won’t count in this contest, but I am interested in what other shareholders think, so feel free to share your thoughts in the comments. Will you be voting for Meyer? For Crystal or do you plan to kick all the bums out? While fighting a proxy war can be a distraction and could potentially interfere with Blockbuster’s efforts to restructure their debt, it can also bring hope to a weary shareholder base at a time when things seem hopeless. I don’t think that Meyer can turn the company around single handedly, but as Johann Wolfgang Von Goethe once wrote, “in all things it’s better to hope than to despair.”

Update – In an open letter to shareholders, Meyer calls out James Keyes for perpetuating the proxy contest and reveals that he encouraged Blockbuster to adopt DVD kiosk technology over five years ago. At that time he also pointed out that Blockbuster could have saved $140 million per year by cutting their store hours by three hours per day.

Most notably, they’ve been trying to strike agreements with studios to delay when they offer new release DVD rentals to their customers. In exchange for lower prices, they’ve agreed to put all of the new movies by Warner Brothers on very long wait status for their customers. In exchange, they get lower prices that will help them to drive brick and mortar competitors out of business. So far most studios are only watching these experiments from the sidelines, but Warner Brothers has embraced this scheme with gusto and has followed up their agreement with Netflix by striking a similar deal with Redbox.

Ironically, Redbox actually dismissed an anti-trust claim against Warner Brothers, in exchange for being invited into this exclusive club. Now some will argue that the beauty of Netflix is their deep archived content and while 487 or the 488 movies in my queue currently show availability of now, they’re customers who do like to rent new releases. By making them wait, Netflix is creating an artificial rental window that allows Warner Brothers to charge higher prices for new release DVDs and causes the price for rentals to rise at rental firms like Blockbuster. In fact since striking these agreements, Blockbuster has raised prices on their DVD by mail program and reinstated late fees to their customers. This is a reversal of the price wars that consumers enjoyed over the last decade.

While Netflix and Redbox haven’t seen much in the way of customer defections from implementing this hostile policy, they may find their activities under closer scrutiny thanks to Susan Uman from Manhattan. In a lawsuit against Netflix, she argues that this latest rental window is nothing but anti-competitive collusion. Already, Netflix has been sued over a different arrangement with Walmart to carve up the sales and the rental markets, so it will be interesting to see how this one plays out.

According to USLegal.com, “collusion occurs when two persons or representatives of an entity or organization make an agreement to deceive or mislead another. Such agreements are usually secretive, and involve fraud or gaining an unfair advantage over a third party, competitors, consumers or others with whom they are negotiating. The collusion, therefore, makes the bargaining process inherently unfair. Collusion can involve price or wage fixing, kickbacks, or misrepresenting the independence of the relationship betweeen the colluding parties.”

While there is a fine line between collusion and standard industry business agreements, the deal that Netflix made cheats customers out of new releases and I think it crosses that line. They have in effect sold their first sale rights, in exchange for financial terms that give them an economic advantage over smaller competitors in their industry. According to this primer by the Justice Department, collusion tends to occur when we see some of the following conditions.

“-Collusion is more likely to occur if there are few sellers. The fewer the number of sellers, the easier it is for them to get together and agree on prices, bids, customers, or territories. Collusion may also occur when the number of firms is fairly large, but there is a small group of major sellers and the rest are “fringe” sellers who control only a small fraction of the market.

-Bidders who congregate in the same building or town to submit their bids have an easy opportunity for last-minute communications.”

Looking over this list, it would appear that Netflix is very much in a position to abuse their market leadership status. With Movie Gallery in bankruptcy for the 2nd time and Blockbuster getting close to a date with the grim reaper themselves, Netflix and Redbox represent the future of the DVD rental industry. This limited competition has made it easy for them to enter into agreements that wouldn’t have been tolerated by customers five years ago. If Blockbuster had the finances to actually keep new releases in stock, one might argue otherwise, but their company is in survival mode and are now having to pay Warner Brothers more for each new release then their two biggest threats.

While Netflix and Redbox may not have their headquarters located in the same town, both have been aggressively courting Hollywood for access to their movies. Since the studios are largely controlled by a small handful of companies, it gives them the ability to collude with the limited DVD renters that are left.

Prior to their agreement with Warner Brothers, Redbox was on the outside of this club and was being forced to acquire their DVDs from outlets like Walmart because Warner Brothers refused to even do business with them. Now that they’ve stopped sticking up for the consumer, they have access to all the DVDs that they want to buy. If this doesn’t qualify as collusion, I’m not sure what does.

It’s hard to say how much legal merit this lawsuit will have, but from my viewpoint, I believe that Netflix, Redbox and Warner Brothers have created an illegal cartel to try and carve up the DVD market. Warner Brother’s gets to force consumers to buy new release DVDs, instead of being able to rent at lower prices and the rental companies get cheaper supply which helps to boost their profits. While I’m sad that Redbox gave up on fighting for consumers, I am glad that consumers aren’t afraid to fight back. Hopefully, Ms. Uman takes this case all the way, instead of settling at the last minute for a million dollar windfall.

Ten years ago, Blockbuster video was on top of the world. They didn’t know it at the time, but it was the golden age for the video store. After years of reminders to be kind and rewind, consumers were adopting DVD players en masse and needed a source for their entertainment needs. For better or worse that source was Blockbuster.

With the internet buzz hitting a fevered pitch, Blockbuster was already hard at work creating a digital strategy. Given their dominate position in the video store industry, they even flirted with the idea of buying a small internet start up named Netflix for a mere $50 million.

With the entertainment world seemingly in the palm of their hand, Blockbuster was positioned to make the jump to digital better than anyone, but over the last decade they’ve made a series of blunders that now threatens to bankrupt them today.

Yet, in looking at their rise and fall, it’s easy to make the quick assumption that their problems were a result of technological innovation, but the truth of the matter is that they have no one but themselves to blame for the weak position that they find themselves in today.

Of all their missteps, the biggest blunder was assuming $1 billion in debt, so that Viacom could collect an obscene dividend payment when they sold the company to a naive public. That debt now hangs over them like an albatross across their their neck and has caused them to lose pace with their unencumbered competitors.

With revenues in steep decline, it will only get harder and harder for Blockbuster to continue to meet their obligations under this debt. Without the firepower to compete on a level playing field, their situation will only get worse

With the precariousness of their position becoming increasingly clear, Blockbuster has done everything from paying a high price to refinance their debt to hiring a bankruptcy specialist to help salvage what is left of their business.

Yet, despite the clear and present danger of their situation, Blockbuster has continued to keep their head buried in the sand. Over the years, I’ve offered my fair share of suggestions criticism for how they could improve their business model, but we’re now at a point where a tourniquet won’t save them, they must do massive surgery and Stat!

In an effort to try and preserve a dying part of the entertainment industry, I present to you, my plan to save Blockbuster.

With the future looking pretty bleak for just about any video store, how can a company like Blockbuster save themselves? By sacrificing their media business in exchange for an opportunity to reinvent their retail business.

What I’m proposing would be tricky and the devil really would be in the details, but with the right execution, Blockbuster could shed their legacy of debt, future proof their business and position themselves to take market share, instead of losing it.

Essentially what they’d need to do is create a “good Blockbuster” and a “bad Blockbuster” to isolate their problems.

On one side you would have their DVD by mail program, their DVD kiosks and their digital business. On the other side, you would have Blockbuster’s traditional video store business that so many are quick to write off.

Together, the two businesses are slowly strangling Blockbuster, but split apart, they could free them from the impact of years of stagnation and ineptitude on their part. What I’m proposing is that they spin off their good assets and use that money to pay off their debt.

In the past, Blockbuster tried to launch an aggressive initiative to boost their DVD by mail program, but by doing so, they only ended up cannibalizing their in store customers. As a result, they’ve all but abandoned the program and have allowed their future to slip away.

If an independent Blockbuster.com doesn’t have to worry about that cannibalization, they could focus on going head to head against Netflix. They could create a subscription program for their kiosks that could offer value that Redbox couldn’t match. They could be price competitive without having to worry about their legacy stores. The result would be a smaller Blockbuster with less meaningful revenue, but it would represent profitable revenue instead of losses.

Neither Netflix nor Redbox would be able to offer DVD exchanges at the kiosk level and through the mail, but Blockbuster could capitalize on both strengths. Yes, the company would be a mere sapling in the larger entertainment industry, but Netflix was once a sapling and they’ve been able to grow into a very large oak.

From the video store side of the equation, Blockbuster could focus on what they do best, maximize cash flow while transitioning their stores into a new business. Whether that means turning their stores into modern day Starbucks or a replacement for the now defunct Circuit City, there are still plenty of opportunities for smart and nimble retailers.

To date, Blockbuster CEO Jim Keyes has made this transition a priority for the company, but when they are forced to forgo tens of millions in capital expenditures, just so that they can service their debt, it limits how quickly they can make this jump. As a result, they continue to face pressure to close stores instead of turning them into cash flow producing machines.

Given all of the negative media attention, it may be hard to believe, but Blockbuster still does a ton of business. For the first 9 months of 2009, Blockbuster brought in over $1.9 BILLION in revenue. By comparison, Netflix brought in $1.22 billion during the same period. Yet, when you look at the differences in market capitalization, Netflix is over 20 times more valuable than Blockbuster.

Perhaps even more surprising is that Blockbuster would have turned a profit of $38.4 million during that 9 month period, had they been able to ignore their debt. Instead, that $38.4 million profit turned into a loss of $131.6 million for the company. Now you don’t need to have a Phd in math to know that losing over $100+ million per year starts to get expensive fast and perhaps even more damaging than the loss of the cash is the effect that these interest payments are having on their competitive ability.

Instead of being able to invest in their future, they’ve been forced to make cut backs. Instead of retrofitting their stores, they’ve been closing them instead. Instead of stepping up the marketing, they’ve been forced to dial back. The result is that more revenue shifts to Redbox and Netflix and their cost to acquire customers has plummeted. If this trend continues, you don’t need Dr. Doom to tell you that it will be curtains for Blockbuster. They must stop the bleeding and they must stop it now.

Now I know what you are thinking, if Blockbuster is a penny stock today, how are they going to come up with $1.6 billion to pay off their long and short term debt. Part of it comes from the assets that they are holding today. With $980 million in current assets, they should be able to keep a good chunk of their leverage in check. The remaining $620 million worth of debt would be paid off by spinning off their new media divisions.

According to the most recent data, Blockbuster currently has 1.6 million online subscribers. As of last September, they had deployed 1,000 kiosks, but were anticipating that they would have over 10,000 deployed by the end of 2010. While Blockbuster doesn’t break down their digital revenues, I think that it’s reasonable to suggest that this division would be worth anywhere between $25 – $75 million based on their market position and intellectual assets.

If you look at Netflix’s current valuation, it works out to be approximately $255 per subscriber. Assuming that you discount Blockbuster subscribers by 30%, it would value Blockbuster’s DVD by mail business at $285 million.

In February of 09′ Coinstar completed their purchase of Redbox at a valuation of approximately $350 million. At the time, Redbox had 12,500 kiosks suggesting a value of approximately $28,000 per kiosk. Assuming that Blockbuster can get to 10,000 kiosks, even at a 50% discount to what Coinstar paid at the bottom of the market, one could assume that this stake would be worth approximately $140 million without Blockbuster’s legacy stores or debt.

What these numbers suggest is that if Blockbuster were to do a spinoff, it’s easily conceivable that they could raise at least $500 million in the offering. Assuming that they start to market their DVD by mail and get it up to 2.5 million subscribers, it would value their new media business at approximately $660 million.

If they did the spin off in the form of a convertible bond, I believe that this number goes even higher, because bond investors could be given the option to return to their current position, if the spin off flopped.

While this sort of transaction would create a new competitor for Blockbuster Video, by getting rid of their debt, it would enable their stores to become profitable once again, which in turn would make it easier for Mr. Keyes to raise money for the marketing and store improvements that Blockbuster so desperately needs.

While I believe that this rescue plan could make Blockbuster competitive again, I don’t believe that their current management is willing to sell off their future, even if it means saving themselves. Despite all evidence of a dying industry, Keyes continues to insist that the video store is the cornerstone of what they do and has consistently defined Blockbuster’s competitive advantage as being able to offer entertainment across multiple channels. While it’s easy to point to Netflix and Redbox as the source of Blockbuster’s kryptonite, I believe that it is their own unwillingness to let go of the past that is preventing them from being a video superhero of the future. Only time will tell how indestructible they really are, but if they continue down the same path, they’ll end up as a mere footnote in the history of the entertainment industry.

Over the last few years, Redbox has been able to build an impressive DVD rental network by being innovative and flexible while their competitors were still laughing at the concept of kiosk rentals. Over time they’ve added features to the Redbox website that allow customers to browse and reserve titles online. They’ve linked their kiosks together so that unlike competitors (ahem: Blockbuster), you can actually rent a movie from one location and return it at another. Redbox’s core business may ultimately be, plain old boring DVD rentals, but there’s no denying that they’ve been an innovator in their industry. This is why I am so perplexed by their most recent decision to go hostile against iPhone owners.

Given the company’s reputation for thinking progressively, I was disappointed to learn that they’ve decided to take a technological step backwards by putting pressure on the Inside Redbox blog, to kill their Inside Redbox iPhone application.

I haven’t jumped on the iPhone bandwagon myself yet, but I can understand why some people think of their phones as an extra appendage. The apps store was a brilliant move by Apple and has created all kinds of interesting software programs that wouldn’t have existed if people had to rely on big companies to build them.

By taking advantage of the GPS features inside the phone, Inside Redbox was able to give iPhone customers the ability to look up which Redbox was closest to them at any given moment. It also allowed customers to find out whether a specific title was available before wasting time visiting the kiosk in person.

The best part about the application though, was it’s ability to reserve movies directly from the iPhone. This means that if you’re standing in line at a Redbox and the person ahead of you is taking too much time selecting a movie, you could theoretically use your iPhone to digitally cut in line and reserve the last copy of Harold and Kumar instead of having to wait impatiently.

When you consider that one of the biggest customer service complaints about Redbox are the long lines when customers try to return DVDs, it blows my mind that Redbox would discourage consumers from using their own mobile device by having them monopolize a kiosk instead.

Whether a customer prefers to order their movies from the internet, a kiosk or the middle of the store while shopping for groceries shouldn’t make a difference to Redbox. No matter what, they are still making a sale, even if they don’t have 100% control over the purchase.

Inside Redbox is mum on details and calls to Redbox’s PR agency didn’t shed any light on the situation, but the two most “controversial” features included in the app is a list of codes for free Redbox movies and the fact that the app relies on Redbox’s website for most of the content.

One theory for why Redbox doesn’t seem to care about iPhone customers is that while they’ve been able to get a lot of buzz using their free movie offers online, consumers haven’t been all that aggressive about redeeming the promotions. Since iPhone customers have access to the most recent free offers while they are actually standing in front of the Redbox kiosk, it makes it easier for customers to take advantage of their specials.

If this is the reason why Redbox killed the application, my response would be that Redbox hasn’t solved their problem, they’ve just made it more difficult to work out a reasonable compromise with their customers. It won’t take consumers very long to figure out that they can bookmark Inside Redbox’s list of free codes or RedboxCodes.com on their iPhones and still have access to the same information.

Rather then fighting progress, Redbox should be using the relationships formed through the application to streamline their movie promotions. They already restrict some of their offers to new customers only, so why can’t they work out a deal for iPhone promotions? Wouldn’t it be better for Inside Redbox iPhone users to have a 10% chance at “winning” a free movie instead of killing the app and forcing these customers underground? By trying to lower the wham hammer on this neat little application, they’ll only end up upsetting customers instead of addressing a weakness in how they’ve choosen to promote their service. Just because the iPhone app doesn’t fit into their mold of what marketing should be, doesn’t mean that killing it is the best solution.

A second theory for why Redbox may have requested that the app be pulled is that Inside Redbox uses Redbox.com’s website for a healthy chunk of their content. Some businesses may object to this and want to have 100% control over how their customers are “allowed” to use their product, but smart companies see the benefits of being open. In fact open API’s are becoming increasingly common in the tech industry. By allowing third parties to mashup and repurpose your data, entirely new creations are possible. This is why some of the most successful companies have business models that encourage outsiders to partner with them. The Inside Redbox app may repackage content from Redbox’s website, but when push comes to shove, it’s really no different than an internet browser. Is it really better for Redbox to force their customers to have a subpar experience using the Redbox.com website on the iPhone instead of an app that is specifically designed to be viewed on the small screen? I don’t think so.

Asking Inside Redbox to pull their program is a bit like asking Microsoft to not allow Redbox’s website to be shown on Internet Explorer. If Redbox really objects to how their content is being used, they have the power to change it. Instead of trying to kill the third party programs that tap into what they’ve already created, they should be encouraging their fans to mix, mash and experiment to create new experiences for their customers.

To date, Redbox has managed to stay ahead of the competition by being nimble and by nurturing a passionate and dedicated fan base. Their decision to now turn on the very fans who cared about them long before their mainstream momentum, says a lot about how fickle their business decisions really are. Instead of acting like the innovator that I know they are, they are acting like a big media company. Hopefully, Redbox comes to their senses and “authorizes” the use of an app that only makes their service more valuable to their customers.

Over the last few years, it’s been no secret that Netflix has become the dominant force for DVD by mail rentals. There may be plenty of other ways to watch films, but when it comes to renting through the mail, Netflix’s laser like focus has put them in the enviable position of being able to assert a large degree of control over the economics of their market. While there is nothing wrong with a company being so successful that they become the dominant player through skill, there are laws against abusing that power to prevent competition.

A few years ago, Wal-mart created a copycat DVD rental service in order to try and get their own piece of the DVD rental market. Their results were disastrous and despite significant financial and retail advantages, the service never caught on with consumers. Eventually, Wal-Mart realized that it was foolish to spend as much time and money focusing on such a small part of their core business, so they threw in the towel and essentially sold their membership base to Netflix. While we know that the agreement included some cross promotional advertising, the actual terms of the deal weren’t ever publicly revealed.

While some would argue that Netflix’s agreement with Wal-mart was just another example of their business acumen, nearly four years after this transaction took place, Walmart and Netflix both stand accused of engaging in anti-trust behavior over the deal. While Netflix does see its fair share of bogus lawsuits, after reading through the complaint, I think that this case may end up having more teeth to it then most of the frivolous lawsuits that are filed (warning, I’m not an attorney, just my uneducated opinion.)

Because the overall DVD market is so much bigger then the online component that Netflix pwns/operates in, I think they’ll end up getting past this, but the complaint which was filed by Andrea Resnick, does do a good job of framing the debate and raises some prickly questions for Netflix/Walmart. Had Resnick tried to seek an injunction blocking the transaction back in 2005, most courts would have brushed aside any anti-trust arguments in a heartbeat, but by shifting the focus of their complaint beyond Netflix’s control over the DVD by mail category to Wal-Mart’s domination of the DVD sell through space, Resnick does a decent job of making his case.

According to the complant, “Prior to and at the time of the agreement, Netflix and Walmart.com were actual competitors in the Online DVD Rental Market. In addition, Netflix, on the one hand, and Wal-Mart Stores and Walmart.com were actual participants and Netflix was a potential participant, with the means and economic incentive to sell new DVDs–in the absence of the Market Division Agreement. Defendants shared a conscious commitment to a common scheme designed to achieve the unlawful objective of dividing the markets for online DVD rentals and new DVD sales. The Market Division Agreement allocated the Online DVD Rental Market to Netflix, with Wal-Mart Stores and Walmart.com agreeing not to compete in that Relevant Market. The agreement also allocated new DVD sales to Wal-Mart stores and Walmart.com, with Netflix agreeing to refrain from selling new DVDs in competition with them. In addition to explicitly or de facto agreeing not to sell new DVDs, Netflix also obtained the Market Division Agreement by providing potentially valuable promotion to Wal-Mart Stores and Walmart.com.”

(Note: bold and italics provided by me)

I don’t know whether or not there was specific language in the agreement preventing Netflix from selling new DVDs to their customers, but I am looking forward to finding out more details during the discovery phase of the trial.

Feel free to read through the complaint yourself, but when push comes to shove, it’s hard for me to believe that the courts will side with Resnick on this one. For one, as Techdirt aptly points out, Netflix doesn’t have a monopoly on the market, they just have the fortunate luck of competing with a neutered Blockbuster for that space. I also would argue that Netflix or Walmart for that matter, doesn’t have the ability to corner the home entertainment market as alleged. If Resnick is successful in arguing that the DVD by mail industry is a unique market they may end up having some luck, but the reality is that the home entertainment market is a helluva lot bigger then DVD rentals via the internet. If the FTC didn’t have problems with Sirius and XM combining to create a single satellite radio company, it’s hard to accept the argument that Netflix’s actions prevented competition on an anti-trust scale.

Since 2005, we’ve seen a radical transformation occur in the VOD and video over the internet markets. During that time, we’ve also seen Redbox install over 10,000 DVD kiosk locations throughout the US, including a large percentage of those in Walmart locations. When you consider that last year, Blockbuster had more then four times as much revenue then Netflix, it begins to illustrate how small Netflix’s slice of the movie rental industry really is.

Only time will tell how far this one will go, but I think it’s worth keeping an eye on. While I’m confident that neither Netflix nor Walmart did anything wrong, the suit isn’t as black and white as I would like. If Netflix does end up having to make compromises as a result of their success, it could have a serious impact on their ability to transition to digital delivery without any turbulence.

The entire rental process was very easy and only reinforced my belief that Redbox will be wildly successful with their business model. In fact, just this morning I noticed that 7-11 has even begun testing Redbox at their stores. I’m not sure if it was the convenience of using a machine instead of dealing with long lines and surly video store clerks or the convenience of being able to make a rental as I was finishing up my grocery shopping, but now that I’ve gotten a taste, I’m sure that I’ll be back.

While it would be hard to improve on the kiosk experience, in thinking about my own entertainment needs, I realized that there is one area of the kiosk market that is still being ignored. When it comes to DVDs, there have been a number of firms who’ve thrown their hat into the kiosk ring, but so far we haven’t seen anyone introduce a kiosk system that dispenses video games.

As a casual gamer, I tend to prefer purchasing my games over renting, but every now and then I end up buying a bomb and get upset that I’m out $60 for a weak title. When it comes to movies, I have no interest in watching the same one over and over again, but I could play a video game for a year and still get just as much enjoyment as the first time I picked it up. While the cost of video games would be higher, I have to imagine that there would be a lot of people like myself who would love to be able to rent a game and keep it, if it happens to rock. In fact, if Redbox (or Gamefly, Gamestop or even [shudder ] Blockbuster) introduced a rent to own kiosk system, I’d probably start buying 100% of my games from them.

Because video games tend to appeal to a more niche audience, it would be harder to introduce these kiosks in places like grocery stores of coffee shops, but I do think that companies like Burger King would love to have junk food loving adolescent males visiting their stores on a regular basis, so that they can check out (and return) the latest gaming titles. The extra cost of the video games would mean that they’d probably need to be charging closer to $3 a rental vs. the $1 bargain that Redbox offers for movies, so it’s possible that kiosk operators would see less demand for this type of service, but I would have to imagine that the sell through rate would be significantly higher, which could go a long ways towards making this idea economically viable.

Another issue that a video game kiosk would face, would be having to stock multiple versions of a game. When it comes to DVDs, a single standard allows you to play your movies whether your DVD player happens to be made by LG or Toshiba, but with video games, you’ve got Sony, Nintendo and Microsoft all battling for the living room, which would mean that you’d have to carry less titles to handle more formats or you’d need to have a company like Sony build kiosks that would exclusively support just PS3 games, even if it meant reducing the pool of potential customers.

While a video game kiosk would have some challenges, I think that most of these could be easily solved. I’m not sure why we haven’t seen anyone come out with a product like this yet, but I believe that there is a great market opportunity for the first one to make a move. Currently, it takes about 9 months for a Redbox kiosk to completely pay for itself. Even if it took twice as long for a video game kiosk to pay off, it’d still make an incredible investment for most businesses, even before you consider some of the extra benefits like driving more traffic to the retailer. I’m not sure whether or not someone will seize on this opportunity, but if they do, you can bet that I’ll be a customer. While I may have more then enough solutions when it comes to getting movies, getting a video game can still be a hassle.

What do you think, if someone allowed you to rent video games from a kiosk for $3 a day (or buy them for $50 – $60), would you be interested or is this just a niche market for people too lazy to drive to Gamespot?

It’s hard to know how popular handgun rentals will be, but if Redbox has success with the program, I bet we’ll see Netflix work out a loaner program with the post office to compete.

Over the last few years, I’ve followed the DVD rental industry pretty closely. During that time, I’ve been one of Blockbuster’s biggest critics and have frequently blasted the company for failing to adapt to the digital age. With their core rental business experiencing massive deterioration, I’ve had very few positive things to say about the company.

Their hyper-focus on competing with Netflix, has cost the company dearly and was a huge blunder by Blockbuster’s previous management. In order to try and counteract Netflix’s momentum, Blockbuster ended late fees, started a price war against a well funded innovator with little debt, and they massively cannibalized their higher margin in-store business. All in a desperate attempt, to differentiate their online service. Meanwhile, their executives took home pay packages that were unconscionable, especially when you consider Blockbuster’s dwindling resources and their dismal financial performance.

At the end of the day, their fight against Netflix has cost them at least a half a billion dollars and they still only have 3,000,000 subscribers.

Six months ago, I would have told you that there was nothing that Blockbuster could do to save itself. I had seen Antioco and Co. make too many poor decisions, to believe that they could figure out how to turn the company around. Instead of increasing prices, they were lowering them by offering unlimited total access rentals. While the program proved to be popular with consumers and the Mad Money crowd, it wasn’t an acceptable long term solution for the challenges that Blockbuster faces.

Of all the decisions that I’ve seen the company make, squeezing out Antioco may have been their best one. Ironically, the one move that I think was good for shareholders, turned Mad Money against them and started the spiral towards a new 52 week low today.

With so much going wrong for the company, I had low expectations when they brought in Jim Keyes to takeover at the helm. With the future of rentals being digital, I didn’t immediately appreciate the importance of bringing in a retail specialist.

Over the past few months, I’ve watched as Keyes has taken over and while it will take him time to steer Blockbuster back on course, his immediate move to cut advertising and unlimited rentals was one that made economic sense.

What a lot of people interpreted as Blockbuster refusing to face reality, I saw as an admission that they had lost their focus on their most profitable customers. In the short term, this is a good thing because it helps to stem the losses from the Total Access program, but it’s not a long term solution.

Following Blockbuster’s 3rd quarter earning’s call, I could understand why their shareholders might be nervous, but after listening to Keyes unveil his turnaround strategy at their analyst event, I was shocked to see such a negative market reaction to his ideas. Analysts slammed the event as being big on dreams and light on details and since the event, Blockbuster’s market cap has taken a 20% haircut.

What other’s may have interpreted as bad news, I saw as a stroke of genius. Keyes’ prescription for saving Blockbuster is the exact remedy that they need, in order to remain relevant in a digital age. There is little doubt that there will come a time where we see the end of the DVD rental, but for the first time, Blockbuster is willing to admit this and they laid out a compelling plan for how they will adjust to this transition.

Keyes discussed several initiatives, but at the heart of the strategy was a plan to evolve from a rentailer to a retailer. While the differences may be subtle, the details have tremendous implications on the viability of Blockbuster’s business model.

Dedicate More Square Footage To Retail

While Blockbuster has seen their brutal selloff, shares of Gamestop have caught on fire. The market clearly has no faith in the future of DVD rentals, yet they are still willing to invest in profitable retailers. The rental industry is a tough business and as that stream dries up, Blockbuster needs to be able to replace this with higher profit opportunities.

In order to accomplish this goal, Keyes has worked out an agreement with Sony to provide 2000 PS3 kiosks, in their stores during the holidays. I view this as an an early test for the viability of Blockbuster’s retail approach. I believe that the consoles will sell well among Blockbuster’s customer base and will lead towards more high end consumer electronics.

By focusing on selling higher ticket items, Blockbuster stands a better chance of covering their fixed costs. People are already going to Blockbuster to rent their movies, but if they can start to buy things like computers, cellular phones, HDTV’s and Blu-Ray players, it will give Blockbuster an opportunity to capture some of the money that retailers like Best Buy are able to take in.

If Blockbuster is successful with this transition, they could even get to a point where they could use rentals as a loss leader to drive higher revenue transactions. If you can sell enough HDTV’s, the decline in rental revenues becomes less of an issue. What some might see as the abandonment of the rental market is really Blockbuster pursuing better market opportunities.

Invest In Kiosk Technology

It’s no secret that I believe that burn on demand could save the DVD rental industry. As a tech savvy consumer, I have lots of options for streaming digital content to my television, but most people still prefer the good old fashioned DVD. Even after the digital revolution gains critical mass, there will still be a need for movie rentals. While it’s easy to believe that everyone has a computer and internet access, there is still a large part of the market that VOD and Netflix, can’t get at.

The problem with Blockbuster’s retail initiatives, is that this will eat into the selection and inventory. If half the store is dedicated to selling consumer electronics, it becomes challenging to offer as many choices. Burn on demand can solve this issue for Blockbuster. By taking care of the heavy lifting, Blockbuster can make it easy for consumers to watch an even wider range of content.

Keyes plan to invest in burn on demand technology shows that he understands the savings and impact, that this technology can have. My only reservation about his approach, is his intention to introduce the kiosks at the store level. Kiosks can provide a lot of efficiencies, but they don’t do well with volume. I can see the potential in letting franchisees use the technology in non-video store locations, but believe that Blockbuster needs a different solution at the store level.

Everybody knows how to work a printer at the supermarket, but there is a reason why people still go to Kinkos. They can handle volume like nobody’s business.

Burn on demand kiosks will be good for expanding into supermarkets, coffee shops and fast food restaurants, but Blockbuster will need dedicated servers and lots of burners at the store level, if they want to provide a superior experience at their retail locations. By handling the heavy lifting for consumers, they could bypass a significant technological hurdle in the adoption of burn on demand DVD.

Shifting To More Revenue Sharing Arrangements

One of the biggest weaknesses in Blockbuster’s business model are the high fixed costs that they have to deal with. Blockbuster can’t get rid of the lease payments or all of the employee costs, but they can reduce their leverage by approaching their stuido partners. Whether rental will eventually die or not, the studios want to protect the DVD stream and have an incentive to work with Blockbuster towards ensuring their survival. In order to get less up front costs, Blockbuster will be forced to give up their gross margins, but it will allow them to keep top movies in stock and to offer a burn on demand experience.

Raising Prices and Reinstating Late Fees

Over the past few years, we’ve seen the price of a lot of products go up. Whether it’s higher gas prices or postal rate increases, the cost of living has been increasing. When it comes to rental though, we’ve seen price deteriorate. The DVD price war has taken it’s toll and there is more than enough justification for Netflix and Blockbuster to increase prices. This strategy is probably the most risky, because if Netflix didn’t follow through with their own price increase, there could be a severe reaction against Blockbuster.

One of the things that has always impressed me about Netflix, has been their commitment to testing ideas before implementation. When Blockbuster ended late fees, they took a shotgun approach and hoped that it would pay off. It obviously didn’t.

When Netflix lowered prices it was after they understood the elasticity of the demand curve. By taking their time to react to competitive threats, Netflix was able to make more intelligent decisions in combating Blockbuster. While I’m sure that Blockbuster shareholders would welcome an imediate price increase, I have to admire the fact that Keyes isn’t willing to dive in head first on this one.

As far as the late fees goes, this is clearly a problem. By allowing customers to keep rentals, it’s prevented other people from having access to the inventory. I think it’s fair for Blockbuster to consider this move, but after such a massive no late fee campaign, there could be a strong backlash. One of the problems that I think most people had with Blockbuster’s late charges was the punitive nature of the fees. Instead of having to pay for one more day, you often had to pay for another three day rental.

During the analyst presentation, Keyes expressed admiration for Redbox’s pricing model and pointed out that a $1 a day wasn’t really cheaper then Blockbuster. If Blockbuster had $3 rentals for three days and then a $1 per day afterwards, consumers might accept the return of late fees. Still, after such a massive promotion (and lawsuit settlements), it would be gutsy to try and re-introduce them.

There is no way to know for sure, if any of these initiatives can save Blockbuster, but I do believe that Keyes is making the right moves towards securing the long term future of the company. While I may have written off the video store, I’m not ready to call the end of retail and I’m impressed by Keyes focus on improving revenue per square footage, instead of being distracted by the internet. It’s the right move for Blockbuster to make and one that marks the divergence of the Netflix vs. Blockbuster paradigm. With rental revenues set to eventually expire, Blockbuster is smart in positioning themselves to take on other retailers, where they have an advantage. By making these changes, it shifts the battle to Blockbuster vs. Circuit City, Best Buy and Game Stop and this is a business model that should make more sense to Blockbuster’s investors.

Last week, Blockbuster made a pretty big splash after they announced that they were going to support Blu-Ray exclusively at their retail stores. The move prompted a lot of people to ask if this was a sign that HD-DVD was dead in the water. After all, Blockbuster has a significant retail presence and their support for one format could be interpreted as a sign that consumers are demanding Blu-Ray over HD-DVD.

On the surface, this explanation seems to make sense. Blockbuster even went so far as to tell people that 70% of their test stores were choosing Blu-ray content. Sooner or later Blockbuster was going to have to choose a format and by doing it publicly, they were able to control how that information got out. Irrespective of their motivation, the move was smart on many levels and helped Sony to shift momentum back to Blu-ray, in the never ending format wars.

It could be that this is all there is to this story, that Blockbuster choose their customer’s preferences over corporate interests, but as a conspiracy theorist, I can’t help, but feel that there is more going on, back at Blockbuster HQ.

It’s entirely possible that Blockbuster’s love affair with Blu-Ray was an isolated business decision, but I suspect that Uncle Sony may have brought a shotgun to the wedding, in order to make sure that Blu-ray stayed relevant.

Over the last year, the DVD kiosk market has started to get hot. Consumers may have been skeptical at first, but once they get a taste, they have to come back. By the end of the year, there very well could be close to 10,000 kiosks in North America.

Even though the current kiosks have proven to be popular, Blockbuster and Movie Gallery have largely sat out of the DVD kiosk expansion. It could be that they don’t have the capital to pursue the technology or it may be that they really don’t see a future in kiosk rentals, but I believe, that they’ve been holding out for something even better, burn on demand DVD.

As the DVD kiosk market develops, I think we’ll see two different business models unfold. There will still be the current kiosk that offers a couple dozen choices and an inventory of 500 – 1000 discs and there will be the burn on demand machines that will carry 2,000 – 3,000 different movies that you can burn at the retail level. The current kiosks will be popular because they take a relatively low investment and the owners can control the costs of the content because of the fair use doctrine. If you play your cards right, you can make the kiosk pay for itself in the first year you own it. These are especially well suited for adding DVD rentals to a high traffic locations that normally couldn’t support a video store.

Unfortunately though, for a lot of retailers, the limited capacity of today’s kiosks prevents them from using the technology in more powerful ways. If you can’t replace your entire inventory with a limited number of discs, than it’s hard to convince the video stores and big box retailers to adopt the technology. While today’s technology will play a vital role in the future of the DVD rental market, it will be burn on demand that has the potential to save the video stores from extinction.

To a certain extent, Blockbuster will be interested in using the burn on demand kiosks in order to minimize real estate and cut down on employee costs, but the real benefit of the kiosks will be the new franchising opportunities that will open up to them. As the video store industry has gone into consolidation mode, Blockbuster’s franchisees have had a very difficult time adjusting to the new rental environment. Disagreements over the online program and the end of late fees, has even caused one of their first franchise owners to sue Blockbuster for breach of contract. As the market has collapsed, attracting new capital has been difficult and Blockbuster has struggled in replacing this lost revenue.

One of the problems with the stand alone burn on demand kiosks, is that these will not be cheap. It will take a healthy chunk of capital in order for Blockbuster or Movie Gallery to take advantage of this expanding market. With the introduction of the technology though, Blockbuster can leverage their brand by offering franchisee investors an opportunity to help create a new automated video store network.

This would help to raise outside capital that isn’t dilutive to Blockbuster shareholders, doesn’t increase debt, and would give smaller investors, a direct opportunity to invest in the growth of this emerging market.

When it comes to Blockbuster’s retail stores, I believe that they’ll look less like a kiosk and more like a Kinko’s. Blockbuster would be well served in studying the success that Paul Orfalea has had in building his company. The same concepts that he applied, will be key components for maximizing the success in using the technology. Burn on demand at the store level will need to work like a machine, in order for Blockbuster to provide the optimal retail experience, while minimizing their costs at the same time.

Little things like allowing customers to select a film online and have it available for pick up will matter a lot. They may even be able to charge higher prices by guaranteeing that you can always get the movie that you want. With a server and a couple of fast burners, Blockbuster could reduce the size of their real estate and improve customer selection at the same time.

For Blockbuster the stakes are huge.

Unfortunately though, the stakes for Sony are even bigger and while the technology to deploy burn on demand has been here for a very long time, like anything involving Hollywood, it’s been tied down over disagreements tied to the licensing of formats. Last December, things looked promising, that we might be witnessing the birth of this technology.

Time Warner CEO Dick Parsons said that 2007 would see the introduction of burn on demand technology for their retail partners, the DVD forum even “approved” a standard for the DRM, and in anticipation of the launch, Sonic solutions went as far as to announce that they were launching a commercial and retail solution using the technology. Despite all of these signs of this technological evolution, somehow the licensing discussions got hijacked by the DVD-CCA, and everything started to break down.

While Blockbuster hasn’t publicly discussed their burn on demand ambitions, there have been hints that they’ve had their eyes set on this target. Earlier this month, Lionsgate’s CEO Jon Feltheimer said that the company had digital distribution agreements in place with Best Buy and Blockbuster. Many in the press, assumed that he was referring to a movie download service, but no one stopped to consider whether or not “digital distribution” could occur at the retail level. Later, Feltheimer backed away from the comments, which could be interpreted as a sign of on going discussions.

Many retail and technology companies had hoped that Hollywood could come to a decision, but over the last six months, it’s been nothing but a series of delays. When the group met last April, they still couldn’t resolve their impasse and the decision was put off for another two months, while the studios considered their alternatives.

While there is no way for me to know what goes on behind the closed door DVD-CCA sessions, what I do know from my sources in the kiosk industry, is that the disagreement over the licensing has largely been between the studios, not the consumer electronic companies involved. At one point, Sony was even looking into building their own DVD kiosks, that would burn Sony films exclusively.

This would obviously be a less than ideal solution for consumers and retailers, but it suggests that whatever the core issues are, Sony is concerned enough about them, that they are willing to ostracize their customers, in order to maintain their hold on the DVD market.

What makes me suspect that Sony may have brought a shotgun to Blockbuster’s wedding, is the timing of the announcement of their engagement. It was a week and a half before today’s meeting, where the DVD-CCA, (cough: Sony) will decide whether or not consumers should be able to buy a burn on demand DVD or whether it poses too much of a piracy problem

Coincidently enough, two days before the meeting, Rimage, also issued a press release where they mentioned their love of “Blu-ray” six different times. Rimage also recently announced a $6.5 million order from an unnamed “national retailer”. Rimage helps to make DVD publishing systems, Sonic makes the DRM.

Now, this is just speculation on my part, but considering that Sony owns half of the patents in the DVD-CCA licensing pool, I’m going to assume that they’ve got some control over what happens with the DVD-CCA. If the DVD-CCA can’t agree on a decision, than it might delay Sony’s digital plans, but it would certainly mean a lot more to a company like say ohhhh I don’t know, Blockbuster? It’s easy to dismiss, Blockbuster’s acceptance of Blu-ray as a day to day business decision, but in the larger context of their digital strategy, I think the move very likely could have been made, to shore up Sony’s support for the burn on demand technology.

While the DVD-CCA did meet today, I haven’t been able to find out the decision. They don’t like a lot of public attention and haven’t posted anything publicly. They did post their support for a law making all DVD copying illegal though. It’s hard to argue with them, I can only imagine how terrible it would be if consumers were allowed to make fair use copies of their content.

It could be that I’m reading entirely too much into this, but after watching Sony destroy their own PS3 with a forced Blu-ray “upgrade”, I wouldn’t put it past the company to try and use their muscle on the DVD-CCA board, in order to squeeze a retail partner like Blockbuster. You can call it payola or you can call it smart business, but it’s hard for me to blame Blockbuster, even if their “support” for Blu-ray may have involved a little tit for tat.

If it unlocks the key to burn on demand, then Blu-ray is a small price to pay, for a real shot at long term survival. Until, the studios can figure out a different economic equation, the video stores won’t survive the commoditization of media.

Update – It looks like it’s official, or at least sort of. I’m not sure if Blockbuster’s support was what it took, but the DVD-CCA finally authorized burn on demand for consumers and retailers. The paperwork won’t be signed until next week, but the move opens the door for a brand new market to unfold. It will take time for the rollout of actual products, but I expect that it won’t take long before we start seeing plenty of retailers adopting the technology. It’s way to early to tell how this market will shake out, but I expect to see lots of competition.

During 2006, DVDPlay continued to demonstrate phenomenal growth for their brand and now has over 1,000 DVDPlay branded locations, on top of another 1,000 non-branded locations that consumers can rent from. The company also announced that in 2007, they are planning to continue their aggressive rollout of kiosks by adding another 2,000 locations to their program.

Considering that just a year ago, DVDPlay was announcing that they had rented their 4 millionth DVD over the life of their business, it pretty amazing to see them add another 2 million DVD rentals, just over 2006 alone.

With demand from consumers and retailers clearly continuing to increase, DVDPlay is starting to gain serious traction in the market for DVD rentals. In addition to hitting these growth milestones, the company also announced that their rollout into Arizona is almost complete and they now have kiosks located in 90% of all Arizona Safeway stores.

The official word from Safeway is that it’s still too early to gauge the success of these rollouts, but from their comments, it’s clear that even if the machines were running at breakeven, there is still a huge benefit for them to give up 5.5 square feet of their store, in order to be able to offer DVD rentals to their customers.

“Safeway spokeswoman Nikki Daly said its too early to determine how popular the kiosks are with customers. “This is just another way for us to offer convenience to our customers,” she said. Daly said the company phased out video departments in many of its stores because they were too much of a drain on staff and consumed too much space.”

With more and more retailers taking a closer look at offering DVD rentals to their customers, DVDPlay sits in an attractive position to capitalize on this trend. If they do end up tripling the number of kiosk locations by the end of this year, it won’t take long before these developments start having a real economic impact on traditional video stores. While the selection on a kiosk can’t replicate what’s available at a local video store today, the convenience of kiosk rentals and the ability for the industry to deploy machines quickly and cost effectively, could put enormous pressure on an industry that is clearly very much in flux.

So far, grocery stores have been the most likely locations to adopt the DVD kiosk, but the more popular this technology becomes, the greater the potential that this market has to grow . With coffee houses, fast food restaurants, gas stations and quick serve convenience stores still without a DVD rental option, the growth potential of this market is really quite extraordinary. With many retailers only putting their toe in the water during 2006, I expect that we will see significant demand for DVD kiosks increase in 2007.

2006 may have turned out to be a record year for the DVD kiosk industry, but with with all three of the major kiosk players planning aggresive growth in 2007, I have even higher expectations for what we’ll see by the end of this year.

When I was a kid, people took the time to figure out a way to short circuit Coke machines into giving away free sodas, by spitting water into the slot for dollar bills. Considering that Zoom systems is catering to a much higher end of the retail market with their iPod and cell phone kiosks, it shouldn’t be much of a surprise that hackers have already figured out a way to get around the theft protections built into the Zoom vending machines.

Because Zoom is using internet explorer to run their kiosk software, hackers have figured out that it’s relatively easy to bypass their security protections by accessing the file explorer window and then tricking the machine into thinking that you’ve already paid.

Since most of the Zoom’s kiosks are either inside of a Macy’s location or in an airport, this limits the effectiveness of this hack because there are still security guards that can watch out for this, but this hack could still undermine the usefulness of kiosk technology, if you have to have physical security monitoring the machines. While I’d be surprised to find out that Zoom hasn’t already responded to this threat by making it more difficult to gain access to the file explorer window, this hack still highlights an important issue for kiosk manufactuers to consider when designing their vending solutions.

By removing an actual human from the transaction process vending can save time and money for many businesses, but without the right theft controls, it can also expose retailers to even higher levels of theft. Even with this exploit, I would still be willing to bet that retailers see significant less shrinkage with Zoom kiosks than without them, but for a technology that depends upon removing humans from the transaction process, these sorts of exploits are a significant threat to the kiosk industry. If retailers can’t feel comfortable in having an unmonitored vending machine selling their inventory, it will greatly diminish the appeal and convenience that vending can have as a retail solution.

Setting the gold standard for the kiosk industry, Zoom Systems has revealed that they’ve taken in $55,000 worth of iPod sales from just 1 vending machine at an Atlanta airport over a single month. This is an amazing amount of revenue from a kiosk and may offer a glimpse at how we’ll see high end electronics sold in the future.

Earlier this week, Sanford Bernstein said that they estimated that Apple earns about $4,000 per square foot at their retail stores each year. While this is an impressive number in it’s own right, if Zoom can replicate this type of volume for a full year, it would mean that they have the potential to earn $20,000 in income for each square foot that they take up.

I’ve seen these Zoom kiosks in action and while they don’t dispense DVDs, they are certainly unbelievably hot. Consumers love them and want to try them out, just to use them. The machines are simple enough to use, consumers pick out the type of iPod or accessory that they want, put in their credit card and then the machine gently gives them consumer electronic love. The whole process is actually easier and more enjoyable than a traditional retail transaction and Zoom doesn’t have to pay their robots overtime.

Over the last year, Zoom raised $10 million in round C funding and another $35 million in round D funding just six months later. With a very hot kiosk design, an emphasis on high end retail and backing from investors like Goldman Sachs and Motorola, Zoom is well positioned to lead the kiosk industry from snack foods to luxury goods.

DVD Play’s system is set up very much like the other DVD kiosk players, except they use smaller machines and charge more for their rentals. Their machines only hold 500 discs and they typically offer between 25 – 50 movie choices at any given time. Recently, I asked the Safeway manager near my house about how popular the machines were and he estimates that they rent about 20 DVDs per day from his location. Because the DVDs are $1.50 for the rental and $1.00 for each day after, it means that they need to rent less to be profitable. If DVD Play demonstrates success at these price points, it will be a good test case in how elastic DVD rentals are, once you increase the price over the $1 per night.

One thing that was clear from my conversation with the Safeway manager was that he was really happy to have the machines in his store, regardless of the number of rentals that they achieve. He felt like it added to customer satisfaction and that it gave the store something that they haven’t been able to offer before. In a news article from the Payson Roundup, he’s clearly not the only manager who feels this way. In the article they reveal that DVD Play has started their expansion outside of California and is now rolling out kiosks in Northern Arizona and they also discuss some of the less tangible benefits that Safeway is seeing as a result of this rollout.

“We don’t own or service the kiosk,” said Dan Dillon, Safeway store manager. “We have a contract with the company that does own it, but we’re glad to have it. This is just one more convenience for our customers. People can pick up their prescription, grab some flowers, get a coffee at Starbucks, and then a movie — all in the same ten minutes.”

When looking at the DVD kiosk market, there are really two different customers that need to be served. There is the consumer, who ultimately rents the DVD, but then there is also the retailer who is providing the floor space for the machines. In watching the growth of this industry it’s become clear that retailers like these machines even more then the customers do. Renting DVDs can be a real pain for a grocery store. It takes staff, inventory systems and precious floor space. On the other hand, putting a DVD kiosk near the exit of a store barely takes up any floor space, needs little servicing and has it’s own automated inventory system built in.

Recently, DVD Play hired Dennis Lucas as an Executive Vice President. Lucas was a brillant acquistion for the company and previously had spent most of his career working his way up the corporate ladder of the Albertson’s organization. Just like Netflix depends upon the postal system to act as a distribution partner, the kiosk companies use grocery stores to act as theirs. With Lucas’ extensive background in the grocery industry, he brings skills that will prove invaluable in how DVD Play is able to better serve their grocery partners and demonstrate these less tangible benefits. I see hiring Lucas as being akin to when Netflix hired the former postmaster general to act as their liaison to the post office. While it’s still early for Lucas at the company, I have high expectations for what he can bring to the operational side of DVD Play’s business, as well as to the negotiation table.

DVD Play’s expansion into Arizona makes a lot of sense from a geographical standpoint and could represent a real turning point for the company. DVD Play was founded in 1999 and while they’ve seen slow but steady growth, it’s been anything but explosive. While the company may have gotten off to a slow start, more recently things have been progressing quite nicely for them. At the end of 2004, things looked pretty bleak, but in 2005 the company saw a 200% growth increase and by the end of 05′ they had rented over 4 million DVDs. In 2006, growth has continued to accelerate and they added another 1 million DVDs to this total in the first six months of this year alone. This works out to be an average of approximately 32 DVDs rented a day from their machines.

With the pickup in volume, DVD Play conducted a second round of VC financing and raised another $20 million to help fund further expansion. This brought the total capital that they company has raised to $40 million.

The company plans to use this capital to expand into 1,000 locations by the end of 2007 and has previously said that they would target California, Texas and Florida as ideal locations for this growth.

While DVD Play may have gotten off to a slow start, their recent success and their expansion into Arizona is another clear signal that the DVD kiosk industry is strong, healthy and growing. While I don’t fully understand why it has taken consumers so long to embrace this technology, it’s clear that consumer habits are changing and that more and more businesses and people are becoming comfortable with using kiosks. As video stores continue to come under pressure from a variety of competition, the DVD kiosk will serve an important role in capturing customers who still want instant gratification, at a fraction of the cost of operating a full scale retail store.

With retail partners moving past the beta phase of DVD kiosks and into the deployment phase, TNR needed a solid backend system that could help them tie all of their machines together and IBM is a natural fit. The multi-million dollar contract will initially run for three years and will enable TNR to focus on aggressively developing their business without having to worry about the constraints that their growth might have to their infrastructure. In a press release announcing their implementation of IBM’s MySAP program, TNR gives some of their rationale behind wanting to outsource their backend software needs.

“At the beginning of the year, we realized that, with our major growth initiatives underway and the tremendous amount of data flow inherent in our business, our systems didn’t have the management tools we needed, now or for the future. IBM was able to quickly assess our needs, develop an IT infrastructure and manage it for us,” said Jay Whitney, vice president of operations for TNR Entertainment. “With the on demand hosting model, we can focus our efforts on expanding the business without having to invest in an entire IT infrastructure from the ground up.”

While taking care of these backend needs will undoubtably solve some of the major headaches that TNR Entertainment faces from a business perspective, from the press release it’s unclear if it solves two of the major pieces that the company is missing from a consumer perspective.

Currently TNR Entertainment lacks the ability for consumers to reserve DVDs via the web. TNR has acknownledged that they’ve been working on a solution to this problem and IBM may or may not be able to help with that process. One thing is clear though and that is without webervations, it will make managing upcoming burn on demand technology very difficult from a logistics perspective. While it’s still early in the DVD kiosk cycle to get too excited about burn on demand functionality, recent comments by Time Warner CEO Dick Parsons and an agreement by the DVD Forum to support this feature in 2007 indicate that the technology is well on it’s way towards being accepted by the major media players in the upcoming year. If IBM is able to assist in tying together the backend inventory with an online inventory that consumers could use, it would go a long way in improving the quality of service that TNR Entertainment is able to give their customers.

The second missing piece of the TNR consumer equation is their inability to accept returns at a different kiosk then the one you rent from. While I doubt that most people take heavy advantage of this feature, it’s certainly a nice bonus for those who are taking long road trips and want to swap DVDs or for those who have several different kiosks that they come across during their daily activities. While the press release does not explicity state that this functionality is coming, it’s reference to better inventory management makes me suspect that this could also be something the IBM may be able to assist TNR Entertainment in developing.

With TNR’s kiosks holding 200 titles and a total of 1,000 DVDs, managing inventory can be an especially crucial component of maintaining a consistent quality experience for their customers. While they want to maximize the turnover on their inventory, they also want to ensure that there will always be plenty of choices for customers when they rent from their kiosks.

Near my house there is a DVDplay kiosk located within a Safeway and the last time I counted there were only 68 films in their inventory and at least forty of them were sold out. While this is a small indication as to how successful these kiosks can be even at a $1.50 price point, it’s also a little dissappointing for someone who has gotten used to being able to browse through Netflix’s deep longtail archives for movies that appeal to my niche tastes.

Whether or not IBM’s software addresses either of these consumer issues for TNR certainly doesn’t negate the importance of this announcement. By outsourcing this functionality of their growth the company can concentrate on more important issues like securing distribution agreements and finding more capital to help them accellerate their growth. With VOD eventually set to replace the DVD, TNR Entertainment only has about a decade to establish their brand as a premium player if they want to make the jump to an all digital world. By leveraging IBM’s expertise, they’ve put themselves in a position to deploy their kiosks even more quickly and to manage their network of mini video stores regardless of how quickly or large it seems to grow.

At the time, the merger seemed to make a lot of sense. AOL had a growing internet business. Time Warner had a dusty library of archived content that they were eager to release. By combining both companies, they could create synergies that other media companies couldn’t match. The result however, turned out to be nothing more then disasterous and when AOL officially changed their name back to Time Warner, they all but admited that their tech experiment had gone terribly terribly wrong.

Fast forward to 2006. Time Warner has managed to completely transform their company. They’ve ended their walled garden approach and albeit kicking and screaming, they’ve led the other studios in embracing various digital strategies. With 2006 having brought about a profound revolution in online video, Time Warner has given notice that 2007 will usher in big changes for the company’s film strategies.

On Tueday, Time Warner CEO Dick Parsons, sat down with investors at the Credit Suisse Media and Telecom conference and gave a remarkably candid assesment of his company and their plans for the next year. In his conversation, he discussed the format wars, the competitive landscape of the telecom markets and perhaps most importantly, Time Warner’s digital plans in 2007.

In regards to the format wars, Parsons offered very little hope for consumers who would love to see this silly little battle end. When asked about the potential for the PS3 to be a leader in the HDTV market, Parsons downplayed it’s importance and told the audience that the HDTV flat panel displays would be the real driver for HDTV content growth.

“The format war is unfortunate almost by definition. Because it creates confusion in the minds of consumers, it doesn’t allow a big group to line up behind either one of the formats and begin to drive the costs down so these platforms are going to be out of the reach of the mass market. I mean what is the PS3? Like $600 bucks or something like that? However, even there, I think we’re positioned to take advantage of what uptake there is on the new devices because we’re one of the few studios, if not the only one that is putting out stuff out in both Blu-Ray and HD-DVD.”

While I admire Time Warner for being one of the only studios to be format agnostic and leave it to consumers to decide which is the superior format for the future, I nonetheless disagree that this war was inevitable. The only reason why we haven’t seen broad support for both formats is because of greed. Rather then trusting the markets to decide, both Blu-Ray and the HD-DVD camps have attempted to gain a monopoly on the format and it has clearly backfired as a result.

In discussing Time Warner’s cable assets, Parsons shrugged off concerns about competition from the telecoms. He pointed out that even where FIOS has been deployed, the telephone companies have been acting rationally and are already raising rates in an attempt to profit even after a very limited deployment. While he confessed to not knowing how far the telephone companies would take this video war, he was less then optimistic on satellite’s long term chances in the mix of things.

“If you talk to the guys who really sort of understand, at a profound level, the sort of technological space we’re moving into, a Gates or a guy like Eric Schmidt, and they are the guys who have told me that ‘Geez Dick, you guys with Time Warner Cable’ or I’ll say the same thing with Brian [Roberts] and his cable platform, ‘you don’t understand how far ahead of the rest of the market you are with your platform, it is just that much more robust, it’s going to take these other guys 5 – 6 years to catch up, if they make the investment.’ It turns out they’re right. The cable platform is, in terms of delivering bytes into the home and giving functionality to all of the things you can now do in a digital world, it is just four, five, six years ahead, in terms of it’s robustness and it’s capacity to deliver the telco platform and unless somebody invents something that doesn’t exist today, it will be permanently ahead of the satellite.”

Over the years, we’ve heard an awful lot of noise about FIOS, yet here we are today and there still is less then 1 million households subscribing to fiber in the US. While this is clearly important to the telephone companies, it won’t easily replace the cable systems that have developed over the years. In the long run consumers will benefit from being able to choose between one or the other, just like they benefit from choosing from DSL or cable internet access today, but Parsons may be right that the future of everything on demand may be much further out then anyone expects. While this would undoubtably help Time Warner as a company, I can’t help but feel just a tad disappointed, that the technology is still so far behind where I wish it could be.

After Parsons’ presentation was over, he opened up the conference to a question and answer period. This has always been my favorite part of financial events because often times, this is where the biggest bombshells are released and this event was no exception. When asked about the narrowing of digital release windows between downloads and DVDs, Parsons offered up far more information then I was expecting and mentioned that 2007 will likely be the year that we see burn on demand technology make it’s way into retail stores.

“I think that you’ll see next year, our studios and possible others, going to a download to burn format. The reason we haven’t done it yet is because this has to be worked out and done in cooperation with our existing channel of distribution, I mean you don’t wanna go around the people you’ve been working with in terms of builiding this business at this point in time, so we’ve just seen Walmart for example, go with these little kiosks, it’s all experimental now, these little kiosks in the store where you can actually go and have a download to burn experience instead of having the physical disc and if we do this right, it’s a win win win for everybody. It’s a win for the distribution channel because they avoid a lot of inventory costs and shelf space. It’s a win for the studios, because you avoid a lot of manufactuering costs and you get your product out there more quickly, and it’s a win for consumers because they can get it when they want, how they want and in the format they want it.”

I’ve been fascinated with the DVD kiosk ever since I first had an opportunity to inteview DVD Station and they showed me a DVD kiosk that already had burn on demand technology built into it. While I walked away impressed at the technology, I knew that it would still take years for the studios to embrace a solution this radical.

With the DVD rental stores having been slaughtered in the financial markets and with retailers clearly upset over Apple’s digital download plans of their own, it was only a matter of time before we saw the studios warm to the idea of bringing burn on demand to the retail store level.

By incorporating burning technology into kiosks and retail spaces, video stores and retailers could potentially stock 70,000 films and never have to worry about running out or about it taking up too much floor space. The idea is powerful, the economics could save the DVD industry for another decade and if Parsons’ statement that Redbox is already testing this functionality at Walmart is correct, it may be coming sooner then even I expected.

While it’s taken years for the studios to come up with a sound digital strategy and while I expect that it will likely take even more years to work out an HDTV digital strategy, nontheless I find it very exciting to see these developments. With 2007 marking the 7th anniversary of the AOL and Time Warner meger it is nice to know that consumers will finally be able to take advantage of the synergies that were promised when AOL and Time Warner first said that fateful I do.

Basically, when customers show up they now interact with a kiosk instead of with a human. Someone in the back gets the order through a computer and then prepares the meal for the customer. Because the kiosk deals with taking the orders you can avoid spoilage because the kiosk is more accurate and because the kiosk handles the payments you don’t have to worry about the cash register ending up short at the end of the night. In fact even if you get robbed, you don’t even have to worry about them handing over the cash. On the surface, they may not look very tough, but I’ve got it on good authority that they have one armed cousins in Nevada who can be very stingy with paying out money.

I’ve got to say that I find this idea pretty appealling. When I get fast food, it’s not for the food, it’s for the fast. I want in and out with as little chit chat as possible. If kiosk ordering allowed me to order and pay directly, it might actually convince me to go into a Jack in the Box once in a while. Even better, if I could order via the net and pick it up I would be thrilled. I wouldn’t even mind if the cost savings went directly to the shareholders instead of the customers (although it would be nice to see them upgrade to something other then mystery meat.)

With the fast food industry now using centralized drive thrus, kiosk ordering and DVD vending, it’s only a matter of time before the robots take over. Throw in a couple of roombas into the equation and we could have the machines controlling the food supply for the majority of all Americans.

Via Kiosk Marketplace

Atlanta has always been known for their Southern hospitality and charm. The city boasts four professional sporting teams, a vibrant R&B and hip hop scene and of course peaches that make you drool just thinking about them. With the city being known more for it’s leisurely pace of life, then the breakneck speeds that seem to characterize the tech industry, one wouldn’t think that Atlanta would be at the center of one of the hottest shifts in the movie industry right now, yet the city finds itself in the enviable position of being caught in the intersection of two DVD kiosk rivals in the rapidly changing DVD rental industry.

According to a recent press release, TNR Entertainment has yet again raised the stakes in the DVD rental industry by announcing that they’ve successfully installed 170 new DVD kiosks in the greater Atlanta area.

With Redbox currently beta testing DVD kiosk rentals in Atlanta area Walmart stores and with TNR Entertainment now having completed the first stage of their recently announced expanded partnership with Krogers, consumers lucky enough to live in the Atlanta area, will have two more DVD rental companies fighting for their entertainment buck.

At $1 per DVD rental per night, renting DVDs from a kiosk not only fills the instant gratification factor of wanting to get a DVD right away, but it does so at a very affordable price.

In comparing both Redbox and TNR Entertainment, Redbox has the leg up if customers are bad about returning their DVDs. Redbox caps the maximum price for a DVD at $25 after 25 days, compared to TNR’s $35 DVD purchase price if you keep your movie over 14 days. Redbox also offers online reservations that allow consumers to pre-order movies before going to the store, while TNR is still implementing their own webervation system. Of course with both companies charging the same price, the biggest differential will end up being the convenience factor and with TNR’s Kroger expansion, it will mean that TNR will now have approximately five times as many locations in the Atlanta area.

This convenience factor may be the ultimate test for whether or not Atlanta residents will choose one over the other, but frankly I think the market is large enough to support both. Whether one firm wins market share over the other or whether both companies will see success in their Atlanta endevours remains to be seen, but either way the real winner will be the consumers who now have even more options to choose from in how they rent their movies.

The expansion by TNR Entertainment is only the first step in an ambitious plan to add 1,300 DVD kiosk locations to 25 different markets over the next several months. With the rollout of the new DVD machines now well underway, TNR expects to have their rollout completed by early next year.

Over the last few years, Kroger has been very coy in their experiments with DVD kiosks and have been playing both TNR and Redbox against each other for supermarket contracts. Earlier this year, the company forged a deal with Redbox to add DVD kiosks to their Smith’s subsidiary, but then just six months later they awarded a more impressive contract to TNR for the 1,300 locations in their main Kroger stores. While these moves may represent, a desire on Krogers part to keep their DVD options open, it also could reflect a more optimistic reality that neither TNR Entertainment nor Redbox have the capability to fill all of the demand that they are seeing for their DVD solutions.

With Kroger having over 20,000 potential locations, Walgreens operating 5,000 pharmacies, Walmart adding another 4,000 potential opportunites to the equation and Safeway, who’s been using DVDplay for their kiosks, having another 1,800 stores, you can start to get a sense of how large this industry could really get, just through organic growth amoung existing partners.

If you also consider the potential of what could happen if Starbucks decides the right formula for adding their 8,000 stores to the mix or if Target wants to open up their 1,500 locations to DVD burn on demand kiosks or if McDonalds takes this industry international and puts a Redbox in all 31,000 global McDonald restaurants, then you can start to get a picture of how quickly this industry could actually explode. While not every retailer will adopt the DVD kiosk strategy and certainly not everyone will be incorporating them into every store, TNR’s further expansion into the Atlanta area only highlights the real underlying demand for this technology.

While we haven’t seen much direct competition in the DVD kiosk industry to date, Atlanta may very well be an important testing ground for both Redbox and TNR Entertainment. If consumers in Atlanta embrace both solutions, then it will bode very well for the industry. If we see that the head to head competition actually affects sales, then I expect that we’ll see the equivalent of a modern day gold rush, as both firms rush to stake their claim on each city before their rival gains a foothold. Either way though, I don’t see the expansion of this market slowing anytime soon, which means that consumers across the entire US may soon find a DVD kiosk coming to a neighborhood located near you.

Albertson’s has been my favorite grocery chain ever since I moved to Alameda two years ago and had an opportunity to experience their self checkout solution. While many customers still prefer having someone ring up their purchases and bag their groceries for them, I loved being able to ring up my own groceries and then quickly leave the store without having to make idle chit chat with store employees.

Because of their automated checkout system, I would specifically shop at Albertson stores when I lived in Alameda, even though there were more price sensitive grocery stores that I could have used. Albertson’s enhancement of their Redbox agreement, takes this automation philosophy one step further and makes it even more convienent for customers to get their errands done, by letting them rent movies quickly and effectively when they are doing their grocery shopping.

In addition to the expansion of Redbox’s Albertson agreement, the company also announced that they will be supporting four more independent grocery stores chains with their DVD solution. According to the Video Business article

“by January, all 130 Northeast U.S. Hannaford outlets will have Redbox kiosks. The 20 to 25 Strack N Van Til chain, located in Indiana and Illinois, will get machines by the end of this year. Already housing Redbox machines are Maryland’s single-store retailer Chevy Chase and the 18-store Indiana-based Martin’s.”

Between the expansion of Redbox’s current DVD contracts, the testing by Walmart in their Atlanta based stores and the recently announced trial relationship with Walgreens, Redbox is on pace to make 2006 a record year for the company.

Over the last 12 months they have seen the number of kiosks offered double and have their sights set on eventually reaching 20,000 locations nationwide. While at this stage, their kiosk solutions are only designed to fill spontaneous short head demand, I can’t help but wonder if at some point we’ll see the company launch their own DVD by mail program and offer a solution that not only fills instant gratification needs, but can also fill niche longtail demand for more obscure titles. Only time will tell if Redbox goes in this direction, but it would be a natural compliment to their business model and as the company develops a national footprint it could provide real competition to Netflix’s dominance of the DVD by mail market.

On a day where Blockbuster Video had to admit that they were forced to close 343 net stores over the last quarter, Coinstar reported their earnings and gave the investment community a very different outlook on the current state of the DVD kiosk industry.

In short the DVD kiosk industry is strong. Redbox has done exceptionally well this year and over the long term, Coinstar expressed confidence that Redbox can get to over 10,000 locations in the next 3 – 5 years.

Over the last quarter, Redbox has added approximately 200 new kiosks to their program. For kiosks that have been open for over a year, they’ve seen an astonishing 147% improvement in rentals from just a year ago. This is up from the already amazing 105% same store growth that was announced last quarter.

If you look at Redbox’s progress, over the first 9 months of 2006, Coinstar reports that they rented 13.8 million DVDs with the average rental period being 1.5 nights for most consumers. Due to stronger then expected demand for DVD kiosk rentals, Redbox now expects to show a $1 – $1.5 million loss for all of 2006, compared to previous estimates that had placed that number at closer to a loss of $5 million.

With over 900 DVD kiosks having been rolled out over the last 9 months, Redbox now has approximately 1,600 kiosks nationwide. Of these 1,600 machines, approximately 1,000 are located in McDonald’s restaurants and the other 600 are currently, either being tested or in the process of being rolled out by 30 other merchants.

Of these merchants two particularly important relationships were forged over the last quarter. The first was with Walgreens who is currently testing 38 Redbox machines in Houston and Chicago. The second and more significant partner is Walmart who has been testing Redbox vending machines in their Atlanta based stores. While Coinstar stopped short of giving the exact number of Walmart stores that were participating in the tests, by doing a little online sleuthing, I was able to find over 20 Georgia Walmart locations that were listed on the Redbox website.

If these tests with Walmart go well, it would be a huge development for Redbox. With 2006 largely turning out to be a testing phase for most retailers, 2007 is increasingly begining to look like it will be the year that the DVD kiosk begins to go mainstream. Retailers are now showing clear demand for the advantages of bringing DVD rental into their stores and after Walmart tried and failed with their own DVD by mail program, it will be interesting to see if they embrace the kiosk as an alternative way to provide DVD rentals in their stores. While the Walmart program is still very much in a test phase, Coinstar said that they expected that they could see a decision on whether or not an expansion will happen between November 2006 – February 2007.

The DVD kiosk is in an excellent position to take advantage of the misfortunes of the video store. While the selection at a kiosk isn’t the same as a full retail store and certainly isn’t anywhere close to the same as the 65,000 DVDs that Netflix offers, the technology is here to do burn on demand DVDs and I believe that this will be the future of the DVD rental. In the near term, the DVD kiosk will offer short head content that is popular with many consumers and DVD by mail will offer the longtail content that I personally prefer, but as DVD burning gets closer to becoming a reality and if Redbox or any of the other kiosk providers ever combines DVD kiosks with DVD by mail, we will see a very different business model present itself.

DVDXpress has already announced that they are experimenting with a subscription rental business model and with Coinstar owning an option to purchase their company over the next two years, I believe that we could also see Redbox adopt a similar strategy. If the subscription model proves lucrative, it could not only put pressure on Blockbuster and Movie Gallery to innovate, but Netflix as well. With more and more rental options becoming a reality, the end result will be that the consumer will win most of all. While it’s exciting to see Redbox demonstrate such phenomenal growth, it’s even more exciting to realize that the company is still very young. As they move from 1,600 kiosks to 5,000 and then to eventually 10,000, it will be fascinating to watch the effect it has on the DVD industry.