Davis Freeberg’s Digital Connection

Since bursting on the scene 13 years ago, Netflix has been a huge ally for consumers trying to save money. For years Blockbuster had dominated the rental industry and whether it was abusive late fee practices or high rental prices, they took advantage of their strength. The value that Netflix passed onto consumers injected some good old fashioned competition back into the DVD market and led to new forms of innovation. While Netflix continues to remain one of the best values for your entertainment buck, the firm has recently started to engage in some very anti-consumer behavior.

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.

Normally, I tend to think that most regulations are bad. In a free market, businesses should be allowed to operate with a wide degree of latitude. At the same time there is a pragmatic part of me that understands there can be exceptions to this. Everyone should have the right to free speech, but that doesn’t make it right to run cigarette ads on Saturday morning cartoons or to claim that you’re a Doctor when you only bought your degree from an internet spammer.

For the most part, the television world has been forced to accept reasonable restrictions in exchange for the public bandwidth they use to deliver their content. In the internet world though, the content rules are more like the old west because consumers are opting into the service by paying for it. As long as you have the quickest draw, your behavior doesn’t matter as much and so far companies like Netflix have been more concerned about digital market share, then doing what’s right.

Maybe this is because internet audiences are still small compared to television or it could be that it takes time for rules and standards to develop and emerging markets don’t tend to care about these things. Whatever the reason though, there are parts of the television experience that aren’t making the jump to the internet.

Specifically, I’m talking about closed caption data. For years, television studios have been legally required to provide this information, so that people who are hard of hearing can also enjoy the content. While there are some technical issues associated with adding this kind of data to a movie file, technology is at a point where it could easily support this. The Matroska container for example, is able to include optional sub-title information along with video and audio data. Alternatively, because online delivery can microstream to people, files with the embedded sub-titles could made available to viewers who opted into them. This would involve keeping multiple copies of the same movies though and so far the digital movie industry hasn’t wanted to bear this cost.

While I’m loathe to suggest new regulations on a burgeoning industry, I also feel like we have a responsibility to consider the needs of everyone. It costs companies extra money to include wheel chair ramps at their physical locations, but we pay for that as a society because we want to treat everyone as equally as we can. As the traditional line between telecommunications and entertainment becomes blurred, it’s important that we don’t leave behind those less fortunate in life. Having a law that requires subtitles in order to qualify for DRM legal protections wouldn’t be popular with the entertainment industry, but it would fill a void that the market isn’t interested in addressing. Personally, I don’t know whether or not I’d actually support a legal mandate for firms like Netflix, Amazon and Apple to require this data, but I am interested in hearing your thoughts on the issue.

Update – Interestingly enough, I found out that the FTC is actually hosting a hearing (not sure if there was a pun intended) on this topic on Friday Nov. 6. It sounds like the entertainment industry’s position may not be represented, but they will have several prominent members of the deaf community weigh in on the topic. The event will run from 9am – 1pm EST and will be broadcast on the web at the FTC’s website.

When I was a kid, I grew up in middle of the sticks where my parents didn’t have access to cable TV. When satellite dishes first started to show up, my folks were early adopters and bought a ginormous pirate dish (that you’d actually have to crank by hand when you wanted to jump to different channels), but for the most part, my childhood television experience consisted of two fuzzy OTA choices, NBC and CBS.

Back then deciding what to watch was rarely a problem. If I didn’t like what was on one channel, I’d simply live with whatever was on the other. Of course since then, technology (and my life) have changed a lot.

In thinking about my home entertainment setup today, I’m amazed at how many choices I actually have. It’s as if I’ve overcompensated for my lack of choice growing up, by deluging myself with every media gadget or service that comes out today. Between Netflix, Comcast, Amazon, YouTube, a dual tuner HD TiVo (not to mention my dual tuner media PC) and a little friend I like to call Bit Torrent, there is no shortage of content to watch.

While having plenty of choices is fun, having too many can be just as paralyzing as having too few and as more and more technology companies continue to take their shot at crossing into the living room, managing all of this content is going to become an even more important task.

So far, there have been plenty of efforts to improve content discovery services, but the task is apparently, much tougher then I would have thought. Two years ago Netflix offered a million dollars to anyone who could improve their recommendations by 10% and they’ve yet to award the prize.

Over the years, I’ve signed up for a plethora of movie recommendation services, but last summer I realized that it was too difficult to sync my ratings between them all. Since I strongly believe that TV and movie suggestions is a crucial piece of the new media experience, I wanted to make sure that my metadata activity was giving me the most bang for my click. In order to test out the various movie sites, I decided to create a Netflix challenge and conducted a “blind” taste test to figure out what site actually makes the most relevant recommendations.

To set up my experiment, I randomly choose 5% of the 2,000 movies and TV shows that I’ve rated through the Netflix service. I then set up a new profile on Netflix, Blockbuster, Spout and Criticker and manually entered my ratings for these 100 films, into each service. According to Spout, these ratings represented 11.6 days and 181 minutes of time spent watching TV

After I had setup an identical profile on all four services, I then took a look at the first 50 suggestions from each site and compared it to what I had actually rated the film on my main Netflix account.

If the service suggested a movie that I hadn’t already seen, I disregarded it toward calculating the final scores. Essentially, what I wanted to figure out was which movie recommendation service provided the best recommendations based on my actual real life viewing data. After taking a look at all four sites, it was clear that Netflix easily won this challenge.

Of the 50 recommendations that Netflix made, 28 of them (56%) were for films that I had rated 5 stars on my main account. While they did include two 1 star recommendations (Fight Club & American Psycho), the average rating for their recommendations weighed in at 4.18. Critcker came in second place with an avg of 4 stars per recommendation, followed by Blockbuster at 3.96 and Spout at 3.87.

Perhaps even more interesting then the final scores though, were the services that helped me find movies that I had never seen before. Netflix’s results may have been higher then anyone else, but of the 50 recommendations that they made, there were only 11 films that I hadn’t already seen. This compares to 24 unknown content suggestions (48%) from Blockbuster and an astonishing 44 unknown recommendations (88%) from Criticker. In taking a look at the types of movies Blockbuster was recommending, I wasn’t all that impressed with the list of unknown films. Most of them were kids movies that I simply missed because I had no interest in them at all. Trying to decipher Criticker’s picks was a little more difficult because most of their picks were for indie or foreign based films. At first glance it would seem that while Netflix may make more accurate suggestions, Criticker may actually be the best place for finding films that go beyond mainstream audiences.

I’ve listed the breakdown of my results below, but I would encourage you to take these results with a grain of salt. With a sample size of 1, my survey isn’t very scientific and because the ratings of my Netflix sample profile were 100% identical to the ratings on my main profile, it could have influenced my results from Netflix. Nonetheless, at the end of the day, I was pleased to discover that Netflix appears to be the best place for me to be rating and interacting with movies. While I’m hopeful that their open API will eventually allow consumers to port their data between services, it feels good to know that my primary movie recommendation service is the most optimal one for me.

Netflix

Recommendations I’ve Never Seen – 11
5 star – 28
4 star – 4
3 star – 1
2 star – 1
1 star – 2

avg. 4.1794

Criticker
Recommendations I’ve Never Seen – 44
5 star – 2
4 star -2
3 star – 1
2 star – 1
1 star – 0

Avg Ranking 4.0

Blockbuster

Recommendations I’ve Never Seen – 24
5 star – 9
4 star – 11
3 star – 4
2 star – 1
1 star – 0

avg – 3.96

Spout

Recommendations I’ve Never Seen – 11
5 star – 18
4 star – 9
3 star – 4
2 star – 5
1 star – 3

avg. 3.87

Last month Blog Cabins started a pretty cool meme where he lists his favorite movies A – Z. Since I’ve been slacking off on my posts for the last few months, I wanted to go back and share my own list with you. I’ve included some of my favorite TV series on the list as well, since I actually enjoy TV shows even more than movies. For most of the letters, there were clear winners for me, but on a couple of them it was pretty hard to choose. If you haven’t made your own list, it’s a lot of fun to try and put it together, especially if you happen to be a moviehound.

A – Alias
B – Blade Runner
C – The Cable Guy
D – Dawn of the Dead
E – Election
F – Family Guy
G – Glengarry Glen Ross
H – Heat
I – Interview With The Vampire
J – Jericho
K – Kingpin
L – L.A. Story
M – Memento
N – News Radio
O – Old School
P – Planet Of The Apes
Q – Quantum Leap
R – Reservoir Dogs
S – Survivor
T – True Romance
U – The Usual Suspects
V – Very Bad Things
W – Wall St.
X – X-Files
Y – Young Guns
Z – Zero Effect

Netflix sent me an email yesterday announcing their latest promotional offer. The offer allows me to give out a one month free membership to five different friends. This is two weeks longer then their normal free trial and is certainly a good deal for anyone who is interested in DVDs by mail, but who still haven’t tried the service. Of course this isn’t the first time that Netflix has reached out to their customer base for referrals, but this time around they’ve added a new twist by giving their customers an extra free disc for referring Netflix the business.

The addition of the bonus disc reminds me of the Columbia House CD programs that I joined in high school and college. Since Columbia House would give out four free discs for a referral, I worked overtime to sign up all my friends for the service. As a music fan, I got pretty “creative” with the promotions and even worked out CD “revenue sharing” deals with my friends. This time around though, I don’t think I’ll be knocking myself out just for a couple of extra free rentals next month.

While it’s hard to fault Netflix for a smart word of mouth advertising campaign, I do think that they could leverage their customer base even better with a little bit of creativity. Over the last two years, Netflix has continually improved their Watch Instantly service. While the initial rollout was restricted to a limited number of films and to watching it on an Internet Explorer browser, it’s been exciting to watch Netflix rollout more movies and devices to support the service. Netflix still has a ways to go before they perfect their VOD product, but everyday they continue to enhance the service and by the end of the year, I think we’ll see 15,000 titles, Mac support and even an internet enabled television set that is capable of tapping into the service.

Even with these improvements though, if all you did was read the press coverage, you wouldn’t know that the service was any better then when it was first launched. Despite the fact that Netflix now has over 12,000 Watch Instantly titles available, they are still frequently criticized for not having a large enough selection. I don’t really feel that this is a fair criticism though, because it ignores the high satisfaction niche appeal of the movies that are already on the service.

It’s true that Watch Instantly doesn’t have a lot of mainstream hits, but because Netflix has been able to spy on gauge demand by looking at their customer’s queues, they’ve been able to fill about 10% of people’s queues with Watch Instantly selections (while still keeping the cost for their movies affordable for the company.) These may not be the mega hits that drive marketing campaigns for new subscribers, but by letting ME see films like Super Size Me and the Inconvenient Truth or British Sitcoms like Coupling, it’s created an experience that I’ve enjoyed just as much even more then the DVDs that I watched this weekend. With over 50 watch instantly films currently sitting in my queue, there’s been no shortage of high quality films for Freeberg despite what you may have heard about poor selection.

The problem is though, that from the outside all that people see are bunch of lousy b-rated movies that couldn’t cut it on the big screen, even if the Watch Instantly consumers love them.

So what should Netflix do?

I would argue that the company is sitting on a potential viral gold mine with the service. There have been times where some of my posts may get picked up on another blog or two, but I know that I’ve written something really powerful when people start emailing it to each other. With all the buzz and marketing campaigns it’s easy to fake legitimate viral demand, but it’s a lot harder to inspire the real thing.

Netflix can continue to send out friendly reminders and bribe their customers into giving word of mouth by giving them a good deal for their friends and a free movie for them, but how much more powerful would it be if you were allowed to send a specific film that you really enjoyed to a friend or family member for free?

What this would do is change the word of mouth emphasis from Netflix’s service and would instead turn every single watch instantly movie into a powerful emotional marketing channel for them. If you saw a film that you knew your Mom would love and was able to share it with her at no cost, no credit cards and no hassle, how much more likely is it that she’d subscribe to see more films?

Netflix already does a good job of personalizing their recommendations, but by leveraging their customer base through this type of promotion, a user could individualize the gift to the unique tastes of their friends and loved ones. Essentially, it would allow Netflix to match up “lousy” niche watch instantly movies with the long tail demand that really does loves them (without having to know anything about the people in your social circle.)

In addition to creating a more favorable watch instantly impression on new customers, this would also provide a convenient way for their current customers to give “gifts” to the people that they know. Growing up in a big family has its advantages, but just about every month, there is another birthday, graduation, holiday etc. to celebrate. While many of my loved ones deserve to be recognized on these events, it would be really expensive to give out gifts to everyone for minor holidays or accomplishments, but if Netflix limited the program to X number of free movies to give out each month, I could at least send a quick email with a free movie link and some words of encouragement for those not as important events. It may not be the same as taking the time to pick out a real gift, but it would be a way for you to recognized a cousin’s wedding anniversary without breaking the bank.

The threat of course would be that this could potentially eat into gift certificate sales, but Netflix could always turn on and off the promotion depending upon its impact on demand.

There would also be an ancillary advantage to using their watch instantly program as a marketing tool in this way, in that it would help Netflix to leverage the popularity of the service without having to promote the juicy details of how successful they’ve really been. Despite all of their hard work, Netflix’s has been very reluctant to discuss any of the metrics associated with the service, even though they are very likely the number one internet delivery movie provider on the net. Some might argue that their reluctance to talk about their success is a sign of failure, but I believe that they are trying to down play the appeal of subscription based VOD while they still have an early edge on the competition.

Some may also point out that I can already give away five free watch instantly experiences through their current promotion, but I believe that a two hour targeted subscription to Netflix would be 30 times more powerful then their current 30 day offer. It’s hard to know if such a program really would be successful without seeing it in action, but hopefully Netflix would at least be open to experimenting with some trial groups and then taking a look at the numbers. I believe that this type of program would be a runaway success and would make Netflix even more viral without having to bribe their members.

If you’re interested in one of my five free memberships that I have to give out, feel free to leave a comment and I’ll be happy to shoot you the promotional code they gave me, and no, I won’t be sharing my extra DVDs with you, even though you could have squeezed me for two free CDs during my Columbia house days.

Just when you thought it was safe to salvage your Moviebeam box for spare parts, there’s new hope on the horizon that Moviebeam may once again be coming to a television screen near you. Like a zombie from a bad horror flick, Moviebeam continues to rise from the dead feasting on the rotted brains of media moguls and venture capitalists with each new incarnation.

According to the Daily Bankruptcy Review, Movie Gallery has asked for bankruptcy court approval to sell their VOD service to Dar Capital Limited at a $2.25 million price tag.

“Movie Gallery pulled the plug on its-on-demand movie service, called MovieBeam, in December as part of its restructuring under Chapter 11 protection. Dar Capital Limited has agreed to buy MovieBeam, which had about 1,800 subscribers at the time it was shut down. The service required customers to purchase a television set-top box that allowed them to order films for between $1.99 and $4.99. Movie Gallery said in court papers filed Thursday that it began shopping the MovieBeam business soon after shuttering the service and that 14 parties showed an interest in the company. Dar Capital is picking up MovieBeam’s remaining assets, which include certain trademarks and intellectual property associated with the business.”

While the resurrection of Moviebeam will be welcome news for the 1,800 customers who initially ponied up the dough for a box, the sale of the service represents another bitter defeat for Movie Gallery. Just last year, they paid $10 million for the service. Initially, they had hoped to use Moviebeam to strengthen their digital strategy, but when they couldn’t convince in store customers to invest in yet another set top box, they shuttered the money losing service and cut off the early adopters who had plunked down hard earned cash for the box.

If the courts do allow the sale to take place, I’m not convinced that Dar Capital will have much luck in performing CPR on this one. Moviebeam fatal flaw was that that it suffered from a lack of choice and I don’t see this being any less of an issue for Dar Capital. If consumers could get access to everything on demand, paying an upfront fee wouldn’t be as much of a big deal, but with a miniscule selection of movies, it’s hard to justify spending money on a box, especially when you still have to pay for the content.

Even at the heavily discounted price of $2.25 million, this still means that Dar Capital will be paying $1,250 per subscriber. At this cost, they may be better off subsidizing the cost of 2,000 boxes and starting their own service. Then again, it’s entirely possible that Dar Capital is more interested in the bandwidth agreements, then the actual customer base. Moviebeam delivers their movies by piggybacking on PBS’ bandwidth.

Last week, Sezmi launched their wunderbox with promises of a bandwidth delivery system that sounds eeriely similar to the one that Moviebeam implemented. Given the amount of bandwidth that Sezmi will need to deliver on their high definition promises, it wouldn’t surprise me if Dar Capital flips Moviebeam’s bandwidth, instead of turning the service back on. It’s still too early to know what Dar Capital’s end game will actually be, but we should know more on May 8th when Movie Gallery is due back in court.

It’s hard for me to believe that there isn’t prior art for this already, but while I was digging through the US patent website, I noticed that IBM had filed an application for putting non-skipable commercials onto DVDs. According to the application, the commercials could either be updated via the internet or they could be embedded directly on the disc.

“A method wherein contents of DVDs may be restricted based upon purchased certificates is provided. The certificates allow for secured information on playback. Specifically, whenever a DVD is to be played, a certificate is consulted to determine whether the content of the DVD should be played with or without commercial interruptions. If the certificates provide for commercial interruptions, then commercials can be obtained from an online service that renders commercials on demand, or from the DVD itself. In such a case, the content of the DVD may be interspersed with commercials.”

I’m usually a fan of new DVD technology, but I’ve got mixed feelings on this one. Every now and then, I’ll come across a DVD that won’t let me skip past the previews and it drives me absolutely nuts. If I’ve already paid for my content, then should I be forced to watch advertisements? It makes me feel like the studios are double dipping.

On the other hand, I could see plenty of advantages to having ad supported DVDs. There are a lot of people who aren’t willing to pay money, in order to watch a DVD. If they can catch up on a series by dealing with the ads, then this technology could introduce time shifting to an entirely new audience. It could also open up new distribution channels for content providers. For example, if McDonalds included ad supported Disney flicks in their Happy Meals, I’d wager that they would reach more viewers, then Friday nights on ABC.

With advertisers already scared to death of the ad skipping powers of the DVR, I could see studios adopting this as a way of shoring up advertising revenue. I’m certain that the TV producers would prefer live viewers, but if a consumer ends up watching the ads eventually, then why should it matter, when they see the program?

One of the more interesting components to the IBM application, was it’s focus on internet delivered advertising. Whenever I’ve been forced to watch previews on DVDs, it’s typically been for movies that were released a long time ago. While the previews may have been relevant seven years ago, they seem a little outdated today. I don’t think that the free DVD consumer market is going to have the latest internet connected DVD players, but I still found it interesting to learn, that IBM is working on a solution to this problem.

I don’t see this patent making it all the way through the application process, but I do expect that we’ll see more of these types of advertisements in the future. The optimist in me, would love to see this technology used to reach new consumers, but my inner cynic knows that the studios would rather unleash ads on paying viewers, then risk cannibalizing their precious DVD. I don’t fully understand IBM’s motives for filing the patent, but thought that it was an interesting solution for bringing entertainment to the masses.

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.

One could argue that there has never been a better time to be a digital media enthusiast. As the digital revolution continues to unfold, consumers are finding an increasing number of choices in how they want to consume their media. Getting VOD to the television set has taken a lot longer than I expected, but over the last few years, we’ve seen a lot of progress towards digitization. While we still don’t have the holy grail of entertainment (everything on demand), we are getting closer to an on demand environment.

With these choices also comes restrictions. If I buy a song on iTunes, I can’t play it on my Windows “Smart” phone. If I want streaming movies on Netflix, I have to use Microsoft’s browser. While a lot of these obstacles are easy to overcome, this lack of connectivity does frustrate consumers and slows mainstream adoption.

In thinking about my own digital entertainment setup, I’ve set two primary goals for my media library. I want to my video files in DivX or XviD, so that I can use DivX certified devices and I want my media to be in .wmv, so that I can also stream my content to my Xbox or play it on my cellphone.

Currently, I’ve got three or four different digital file types on my computer, but most of the content is in the Mpeg format. I’ve used digital conversion tools in the past, but I’ve never tried to convert all of my media at once, so I wanted to try some of the different conversion software packages, in order to see which ones might be the best at least halfway decent.

When I first went to look for solutions, the sheer number of choices was pretty intimidating. In total, I tried out 7 different pieces of software, but two of them wouldn’t even install. At the end of the day, I was hoping to be able to recommend a solution to my readers, but none of them offered me exactly what I was looking for.

DivX Converter 6.5

Since the immediate goal of my exercise was to get my Mpeg files transferred over to DivX, I figured I would start with the company’s own software before trying anything else. In order to get the converter software, I had to download and install the program from DivX’s website. The install ran pretty clean and other than an optional Google toolbar plugin, there isn’t much in the way of ads. DivX gives you full access to the software for 15 days and after that you have to pony up $19.99, if you want to keep using it.

Of all the conversion software that I tested, DivX was definitely the easiest. Once I installed the program, all I had to do was drag and drop my files and then hit convert. The software was very intuitive. Running on just a half a gig of ram, a 200MB conversion took about 25 minutes to complete. Not as fast as I would have liked, but DivX does offer you a way to queue up your files, so that your computer can do the heavy lifting when you’re not using it.

Had DivX’s software been a little bit more robust, I would have spent the money to go pro, but unfortunately the software has one major weakness. While DivX is more than happy to help their customers convert just about any format into the DivX format, they aren’t as eager to help you get it into .wmv or other third party codecs. I can’t really blame DivX for creating a one way conversion tool, but since it still didn’t help me get my movies to my Xbox, I kept looking.

Windows Media Encoder 9

Because DivX’s converter wouldn’t allow me to convert my files into .wmv, my next stop was to check out Microsoft’s solution for converting into Window’s format. One of the nice things about their encoder software was that it was the only one that was actually free* (Windows software and additional plugins may be required)

The download for the software didn’t contain any ads, but Softie does make you download some bullshit “authentication” plugin before you can actually use the product. The software is designed to help cut down on piracy, but the real end result is that customers are inconvenienced unnecessarily. After trying to verify my own copy of Windows, I continued to get error messages, but was finally able to get my secret code by running their plugin as a standalone app.

One of the things that I really liked about the Windows encoder was that it gave you the option to customize the end product based upon how you intended to use the media. I could encode directly to .wmv, but they also gave me the option of making a smaller file for my cellphone or a larger HDTV file for the living room. Since my goal is to get the videos to my living room using WiFi, I selected the SD version and started the conversion.

One of the things that I noticed when I started to use the program is that once you start the encoding process, it’s a resource hog. This could just be because my PC is already a dinosaur, but from the minute I hit convert, my computer was pretty much worthless. This isn’t a big deal if you are converting files overnight, but if you’re trying to multi-task, it can be frustrating to deal with lagging speeds, while you are waiting for your file to complete.

The software was relatively easy to use, but when it came to it’s UI design, you could just tell that it was created by Microsoft. The whole thing is built to be useful not look good. For my needs, the UI isn’t all that important, but if Microsoft really wants to make this easy for consumers, they should rethink the layout of their software.

Another drawback to the WMEncoder was that just like DivX’s software, Microsoft is a one way street when it comes to the conversions. If all you care about is Windows, this works, but ideally I was hoping to find something that supported multiple file types. I was also a little annoyed to discover that while Microsoft will let you convert almost any codec into .wmv for free, if you actually want to transcode Mpeg files, they make you buy a $15 plugin.

Cinema Forge

Since DivX and Window’s own solutions were less than robust in letting me work with different codecs, I decided to check out a couple of other third party solutions. The first on my list was Cinema Forge. Their software has received good reviews on Download.com and since they allow you to encode up to 10 minutes of video before having to pay the $24.95 to upgrade, it is easy to test the software out.

Cinema Forge supports a number of different files structures and allows you to convert to MP4 (iPod), Flash, .Wmv, Mpeg, .AVI, Real Video and Quicktime. I didn’t have any problems converting into the .Wmv format, but I did find that when I tried to convert my Mpegs into their .AVI wrapper, that it was stripping out the audio and jarbling it on me. I’m not sure, if there was a setting that I had wrong, but after my third corrupted file, I gave up on the software and moved onto other solutions. I also noticed that my .wmv files wouldn’t allow me to fast forward or rewind the content. I’m not sure if this was because I was using the trial version, but I know that I’m not looking for a conversion solution, that locks down my content.

Jet Audio

When I started this project I wasn’t really looking for a media player, but when I saw that the Jet Audio media player also supported file conversions, I remembered the old adage that there may be more than one way to skin a cat. Of all the software conversion tools that I tried, Jet Audio was by far the best. I don’t know that I’d actually spend money on the software, but if I had to pick one, they seemed to offer the most choices and functionality.

One downside for the Apple fans is that their software doesn’t support Quicktime conversions, but since it lets me convert to .wmv, XviD and DivX, I was willing to check it out. In addition, they also throw CD ripping and burning functionality into the software. The trial version only lets you convert 30 seconds worth of a clip, but it was enough for me to at least test out the quality and I didn’t run into any problems.

Two things that I didn’t particularly like about the software were that they included ads for their own PMP devices inside the program and that the software felt really cluttered. While it was an undeniably powerful piece of code, its UI design is more than a little chaotic. In addition to the conversion and burning tools, they also throw in an entire media player. It’s hard to ding them for offering too much, but there is something to be said for simplicity.

Movavi -

Movavi actually had two different software tools that I tested. They have an online version and a downloadable solution. The online version is really good, if you only need to convert small files. There were no programs to download, no accounts to sign up for and no aggressive ads popping up on my browser.

All I really needed to do was go to their website, upload the file I wanted converted, (or give them the web address of where the file is located) and then sit back and wait for an email telling me that it’s ready to be downloaded. It was quick, easy and painless and would have been my final stop, had there not been the 100 MB restrictions on the online version.

Even without the restrictions though, I’m not surer that you’d want to upload files much bigger than 100 MB. I uploaded a 64MB over a fiber connection and it still took 7 minutes to upload, 5 minutes to process, and about 10 seconds to download. This really isn’t a deal breaker for me, but it’s less than ideal, if you are looking to convert full movies. The online version also does not let you convert into .wmv.

Once I downloaded the software version of Movavi, it did add a bit to the functionality. The issue of uploading and downloading your files goes away, as does the 100 MB restriction. The full software also adds support for .wmv conversions including WMV HD. The pro version costs $29.99, but since the free version allows you to convert 30% to a file, I was hoping to test out the quality anyway. Unfortunately, I tried to convert several different file formats over, but no matter what I tried, I couldn’t get Movavi’s software to recognize my media.

Ideally, I was hoping to find an open source free solution, but couldn’t find anything that looked safe enough to download. If someone knows of a good conversion solution, feel free to leave me a comment and I’ll check it out.