Despite Home Entertainment Spending Decline, There is Upside

DVD's for sale
DVD's for sale

A new report reveals that consumers are spending less on home entertainment—but it's not all bad news.

Spending on DVDs, Blu-Ray and digital distribution dropped 8 percent in the first quarter to $4.84 billion, on the heels of a 5 percent drop last year. And the rental business isn't picking up the slack: rental revenues fell 14 percent in the quarter.

The traditional DVD business is responsible for the majority of the bad news. The Blu-Ray business is still tiny but it's growing fast—disc sales grew 74 percent in the first quarter.

The real question, is what's next for digital sales, where margins are a lot higher. Total digital distribution—sell through and video-on-demand grew 27 percent to $617 million in the quarter. That's still just 12.7 percent of the overall market, but the growth is notable.

I spoke to a number of Wall Street analysts today who cover the media giants that have been struggling with declining DVD sales. They were remarkably unperturbed by these numbers. For one thing, they're unsurprised: DVD sales have been declining for a while. And if you factor in the economy, maybe things aren't as bad as they look.

If you figure half of the decline of DVD sales is due to a bad economy, and half of the decline is permanent and structural, then you're looking at an ongoing decline in the mid to high single digits for DVDs as the economy recovers, which is in line with expectations.

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But what happens when physical dollars are replaced by digital pennies? Studios are at best, losing the sale of an $18 DVD and gaining a $4.99 video-on-demand sale through a cable company. Digital margins are healthy because of much lower distribution costs, but overall profits from digital vs. DVD sales are lower as well.

I'm surprised to find that analysts aren't panicking, but instead say that there's a lot to be optimistic about with these new digital windows with options like Video-on-Demand (CMCSA, TWX, CVC) and HBO Go (TWX), which allows subscribers instant access to over 600 HBO shows on their computer.

The rise of digital distribution is heartening because it's a testament to the fact that studios are offering compelling alternatives to piracy. The biggest fear was that people would forgo DVD purchases for free content online. Now it appears that digital options are appealing, and the more people learn about them and try them, the more revenue they'll generate for the studios.

With new products like the iPad creating new demand for *mobile* access to digital content, this digital market will only grow. The more people get used to paying for premium content, the more likely the movie industry will avoid falling prey to the piracy that decimated the music industry.

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