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Redbox: Strategy in the Sunset of Physical Media

Redbox

A corporate strategy article by Thunderbird students Cole Augustine, Cynthia Austin, Bradley Carson, and Jennifer Long

Redbox has seen a meteoric rise to the top of the movie rental business, despite their focus on a dying form of media. As the company's built in expiration date draws closer, Redbox must ask itself, "What Now?" This article will provide an overview of how Redbox got to the top, a preview into the future of the video rental industry, and suggestions for how Redbox can stay relevant in a changing industry.

In the midst of huge losses amongst video rental companies such as Blockbuster and Hollywood Video, Redbox emerged as an innovator by targeting a low price strategy and partnering with other companies known for value to increase volume. Originally a subsidiary of McDonald’s, Redbox entered the market with $1 DVD rental kiosks in many high traffic McDonald’s locations. The Redbox $1 DVD rental price point aligned well to the low income McDonald’s target market, and paying per DVD rental (transaction-based pricing) reinforced the low priced model, translating consumer spending directly to consumption (rather than a subscription-based pricing model where the consumer pays regardless of consumption).

Furthermore, the initial rental price of $1 implied value; the consumer perceived the product was low priced regardless of whether they were charged more due to late fees. By 2005, with more than 1,200 Redbox machines, McDonald’s entered into an agreement with new investor Coinstar and subsequently Redbox was split from McDonald’s. Two years later, Redbox had more than 6,100 locations and had patented its well-known "rent anywhere" system. In 2009, McDonald’s announced that it would sell its remaining stake in Redbox to Coinstar. Coinstar extended partnerships to many large chains that share similar low price strategies (including Wal-Mart, Walgreens, and 7-Eleven), increasing Redbox locations to over 28,000 kiosks in the United States, and expanded the product offering to include DVDs, Blu-Ray discs, and video games for a number of consoles (Redbox, 2011).

Redbox enjoyed significant growth due to their low cost strategy focusing on partnerships to drive volume. Superficially, one could argue Redbox’s growth is consistent enough to forecast the same in the near term; in reality the long-term future for the company could be bleak. In 2010, consumer spending on packaged physical media declined to $3.9 billion, down a whopping 7.1% from 2009, a trend that is expected to be repeated in the coming years (IGN). Although the DVD is predicted to be the primary media format through 2014/2015, it is unlikely that it will remain so past then (Tribbey). A study commissioned by Redbox predicted DVD rentals would remain strong for another ten years (Cluckey), therefore Redbox must create a long term, sustainable strategy with this in mind.

Physical Media Trend.
Physical media, a term used to describe products such as CDs, DVDs, and Blu-Ray discs that are used to store and access music, video, or information, is a format believed by many to be at the end of its lifecycle. In recent years, readily available high-speed Internet and the increasing availability of digital movie and music content have been touted as the reasons for sharp declines in the sales of CDs, DVDs, and Blu-Ray discs in favor of streaming options. The market is shifting from physical media to digital transmission, tightening the DVD rental market. “Physical discs are the dominant source of revenue for the industry but continue to lose ground, posting a 16% decline in rental and sell-through revenues over the two-year period” (Movie Consumption at Home). Beginning in 2008, the US economy fell into a recession, this impacted the sales of physical media for 2009. From 2009 to 2010, Blockbuster lost 20% in revenue while Netflix gained almost 30% (Plunkett), which would indicate a trend away from physical rental. However, Redbox’s unique position in the market encouraged revenue growth, up 50% in 2010 over 2009 and another 32.8% through 2011Q3 (Coinstar Update).

Intellectual property, protected under U.S. law, requires proper licensing to download movies for distribution, which gives movie studios substantial supplier power. Licensing is the highest barrier for entry, as the cost of licensing a media catalog from a major studio is expected to increase to as much as $50-100 Million per year by 2012. As an example, Netflix's annual licensing costs are predicted to increase from around $180 Million in 2010 to nearly $2 Billion in 2012 (Pepitone). Consumers with a digital media mindset place pressure on the supplier power of movie studios as demand for physical ownership declines. “As consumers move from high-margin purchases to low-margin rentals, Morgan Stanley estimated in March that studios’ annual profit per household would tumble from $135 in 2005 to just $89 by 2015” (Edgecliffe-Johnson). However, rather than becoming more open and flexible to new partnerships to offset declines, studios themselves are becoming competitors as they attempt to redefine the shift away from the “nation of renters” mindset providing consumers with both digital rights (using cloud-based models like UltraViolet) and physical rights with each DVD purchase (Bradshaw).

Video on Demand (VOD).
Redbox’s competitors for streaming VOD content include Netflix, Amazon Prime, Hulu/Hulu Plus, HBO GO, Comcast Xfinity, and DishOnline. Netflix reported that 75% of new subscribers in the second quarter 2011 were comprised of the streaming only option (Netflix). The trend in favor of streaming content continued after Netflix announced the split and subsequent rejoining of their physical and streaming business resulting with only 7% choosing the physical DVD. Netflix indicated in investor updates that they “are directing savings generated from declining DVD demand into additional streaming content and marketing” (Netflix). In an effort to expand their product offering and minimize their costs, Netflix also “increased its instant streaming content library through deals with ABC, Nickelodeon, Disney, Twentieth Century Fox and others” (Plunkett Netflix). “Our estimate is that by end of Q3 (2011) in the U.S., we’ll have about 22 million people subscribing to our streaming service, about 15 million people subscribing to our DVD service, and about 25 million total U.S. subscribers (with about 12 million people subscribing to both streaming and DVD)” (Netflix). Thirty percent of Redbox users are also Netflix subscribers (Cluckey). Despite the rapid shift to streaming subscriptions seen by Netflix, or perhaps because of it, Redbox is seeing their share of their DVD market grow; up 10.3% 2011Q3 vs. 2010Q3 (Coinstar Conference).

Expansion into Streaming Market.
On February 16th, 2011, Redbox announced plans to launch a subscription-based streaming video service that will compete directly with Netflix, Hulu, and Amazon allowing users to stream video on multiple devices in addition to accessing DVDs from the company's kiosk network. This subscription-based model deviates from the company's previous transaction-based model and raises the question whether it will work (Los Angeles Times). At a glance, it appears that this service easily leverages the Redbox brand and the financial strength of the company to enter the VOD market. However, the company's major competitor, Netflix, has estimated that its licensing costs will increase tenfold in between 2010 and 2012, making the barriers for entry incredibly high for subscription-based rental companies (Pepitone). In order to effectively compete, Redbox needs to find partnerships with studios that could reduce their licensing expenses while building their streaming libraries. Rather than a subscription-based model, Redbox could utilize a combination of a subscription-based and pay-per-view model, similar to the model Blockbuster has recently introduced (Blockbuster). The combination of a transaction-based and subscription-based model would allow Redbox to leverage their brand to offer on-demand content. They could include "second tier" movies in their subscription-based service and major motion pictures in their pay-per-view and kiosk sites.

Verizon Partnership Rumors.
Rumors abounded in early December 2011 about a Verizon and Redbox partnership to offer streaming media. The rumored plan, set to launch in May 2012, would be a subscription-based model allowing customers to rent DVDs or stream TV shows and movies (e.g. one new release for two credits). Partnering with Verizon provides Redbox with access to over 90 million current wireless customers. Verizon’s network reaches even more consumers, and they plan to increase their speedy 4G LTE coverage area from 186 million people to match their current 3G coverage of 290 million people by the end of 2013 (Verizon Fact Sheet). Through Verizon’s recent partnership to offer FiOS channels on the Xbox 360, Redbox could also gain access to huge number of gaming consoles (Niu). This could lead to large growth in video game rentals. Although there are no plans to offer the service on FiOS set-top boxes, the partnership service would be available on a multitude of mobile and home platforms (Coldewey). The effectiveness of this partnership remains questionable. Neither company has significant experience streaming media nor do they have significant streaming content licensed. Also, not launching in FiOS areas could limit growth. And more recent rumors suggest Verizon may buy Netflix (who already has a substantial library) instead, leaving Redbox to find their own way into VOD (Smith).

International Expansion.
As the use of DVD and Blu-Ray diminishes and online streaming becomes the primary means of movie distribution in the US, Redbox must consider what to do with their physical inventory investments in kiosks and DVDs. One opportunity lies in the global marketplace. Redbox could transition their kiosk approach overseas and introduce their brand to developing countries where technology limitations inhibit video streaming. The US DVD market is not dead yet, but as it dissipates and consumers transition to online streaming, Redbox has an opportunity to build their brand globally and earn revenue through international expansion. They can continue their ‘low priced’ strategy for DVD distribution and partner with international film distributors to also offer local movie and TV series options. A feasible international expansion approach for Netflix would be to focus on the BRICS countries - Brazil, Russia, India, China and South Africa. The International Monetary Fund predicted that by 2014, the original four BRIC economies, prior to South Africa’s entrance as a BRICS economy, will generate around 60% of global growth. These original BRIC nations have “played a pivotal role in the push to maintain global growth in the face of the global financial crisis” (Noury). These large and emerging BRICS economies have large populations with increasing GDP and would be likely to accept Redbox’s current DVD distribution model with obvious adjustments to meet local needs such as language requirements, local distribution partnerships and movie preferences. Most notably, India boasts the most prolific film industry in the world, especially Bollywood the country’s Hindi language film industry, with approximately 1,000 new movie releases per year (Fontanella-Khan). This presents an incredible opportunity for Redbox in an emerging economy with the second largest population in the world that is so obviously devoted to the movie industry.

Redbox successfully focused on its core competencies, low priced appearance and strategic partnerships driving high rental volumes, to succeed in the DVD rental market. Although current threats from competitors in the online streaming industry, such as Hulu and Netflix, exist, the company established a large ‘brick and mortar’ type of footprint and consumer base without the capital investment of actual retail stores. As the industry trends away from physical media toward streaming content, Redbox may enjoy huge potential for growth if they adapt to the decline of physical media as they continue to mature. Entering the VOD market is necessary for their long-term sustainability. A major key to their success will be based on their ability to cultivate relationships with suppliers in order to get newly released movies at lower costs sooner than competitors such as Blockbuster. Facing the challenges of licensing costs and incumbent competition, Redbox must focus on their core competencies in order to sustain their business; expanding into new product offerings, fostering future strategic partnerships, and continuing to open kiosks in new locations (particularly international markets). By adapting their strategy to embrace the consumer trends in movie consumption, Redbox can endure the sunset of physical media and emerge as a leader in the dawn of digital media.

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