Even hearty 3D gains haven't offset declines in DVD revenues

Domestic box office hit a record $10.6 billion in 2009 according to the MPAA and is on track to soar even higher this year. Worldwide box office hit $29.9 billion in 2009, up 7.6% over 2008.

The Blu-ray disc biz also boomed in the first quarter of 2010 vs. the same period last year, with sell-through up 74% and rentals up 36%, per trade org Digital Entertainment Group. Digital distribution, including download purchases and VOD, rose 27% to $617 million.

So why are the studios capping star salaries, laying off workers and squeezing suppliers?

Because none of the gains on the theatrical side, in Blu-ray or via new distribution channels is enough to compensate for the ongoing decline in overall home entertainment, the area from which the studios have drawn their biggest revenues since 1986.

Domestic consumer spending on pre-recorded home-entertainment content — including DVD and Blu-ray purchases and rentals, plus digital distribution — dropped 8% to $4.8 billion in the first quarter of 2010 compared with the same period last year, according to stats the DEG released April 15.

Rentals (which had been a relatively bright spot in 2009) declined 14% in the quarter, while sell-through numbers fell by 11% to about $2.5 billion, and while 3D is boosting theatrical revenues now and offers some enticing prospects for enhancing home-video revenues when the technology ramps up for consumer use down the road, the studios are continuing to see erosion to their bottom line.

The health of Hollywood is often gauged by the mainstream media in terms of B.O. numbers, and weekend box office reports are a staple of TV newscasts. But those aren’t the numbers that drive the studio divisions: Home entertainment brings in 2 1/2 times greater revenue than theatrical does (nearly $26 billion last year, vs. close to $10.6 billion for domestic B.O.), per research outfit Strategy Analytics.

This means box office would have to grow by 2.5% to offset each 1% decline in home entertainment revenue. And that’s not gonna happen.

Given the first-quarter home-entertainment drops, box office would have to jump at least 20% to compensate — and that doesn’t even take into account the fact that film coin is often shared with third parties.

Richard Greenfield, analyst at BTIG, reminds that revenues at the box office are split roughly 50-50 with exhibitors, “so a box office dollar isn’t worth as much as a home entertainment dollar.”

Adds Tom Adams of Adams Media Research, “The studios get up to 75%-80% of the dollars spent at retail, vs. half of the dollars spent at the box office.”

Per Adams, for the past several years, coin from theatrical exhibition has contributed a mere 20%-25% to domestic studio revenues, with most of the rest coming from at-home markets, including rentals and sales, VOD, pay TV and free TV.

Licensing to broadcast, basic cable and pay TV is “easy money” and a steady $2 billion-a-year business for the studios domestically, says Adams, though revenues have been creeping lower. The downside, however, is that some of the deals the studios sign with feevee purveyors like HBO, Showtime and Starz restrict what they can do on the Internet.

“(The studios) realize a bird in the hand is better than accepting less of a fee on the pay TV front to pursue a technology that is not yet setting the world on fire,” says Adams.

For many, a transition to on-demand services represents home entertainment’s best hope.

Steve Beeks, prexy and co-chief operating officer of Lions-gate, points out that while the overall home-entertainment business remains vibrant, the future lies in the growth of on-demand revenue, which he defines broadly to include content delivered via cable, satellite and broadband.

“Not only is on-demand revenue growing dramatically but studios stand to benefit from the significantly higher margins in an on-demand transaction,” he says, “This inherent increase … is enough to lift studio margins for home entertainment overall.”

(Source: Strategy Analytics)

How they handle that growth prospect remains to be seen. When negotiations with the guilds gear up, as they will again this year ahead of contract expirations in 2011, the studios have traditionally cried poverty and fought to avoid giving ground on homevideo residuals. But to shareholders eager for good news in quarterly earnings reports, they routinely tout robust homevideo revenues — even for titles that didn’t do much theatrically.

But, not surprisingly, with lower physical costs and higher potential profit margins, the studios are eager to boost their on-demand revenues. They’re just not there yet.

“The problem is, the smaller home-entertainment segments (i.e., Blu-ray and digital) are growing, but right now it’s not enough to compensate for the decline in standard DVD,” says SNL Kagan analyst Wade Holden.

“The studios need to start figuring out all the different channels to the end users,” says Strategy Analytics’ Martin Olausson. “It’ll be more fragmented. But digital distribution, whether it’s online or within managed cable networks, is where they need to focus. We don’t envision any new packaged media after Blu-ray.”

So while high-profile titles like Fox’s “Avatar” sold 6.7 million copies in four days in North America — 2.7 million of them on Blu-ray — and Summit’s “Twilight: New Moon” sold 4 million units in two days, it would take an awful lot of such collectible titles to reverse the overall trend in home entertainment.

Of course, a key factor in both theatrical and homevideo remains the potential impact of 3D.

DreamWorks Animation topper Jeffrey Katzenberg, in an April 9 interview with Daily Variety, said the additional B.O. revenues generated by premium ticket prices for 3D releases can offset the declines in homevideo.

“The net revenue from a successful 3D release to the studios is greater than the erosion in the DVD market,” he said. “It has been for us (at DreamWorks Animation).”

Going forward, Katzenberg said, 75% to 80% of DreamWorks Animation’s admissions will come from 3D theaters, which charge a ticket premium of 40% to 50%. “Do the math on it. It’s a tremendous opportunity.”

The other studios also are reaping the stereoscopic dividends.

“This year, higher ticket prices for 3D have already accounted for 25% of domestic box office revenue,” says Paul Dergarabedian, prexy of the box office division at Hollywood.com. “The revenue is from four 3D movies,” he added, referring to “Avatar,” “Alice in Wonderland,” “Clash of the Titans” and “How to Train Your Dragon.”

“If you took 3D out of the equation, we’d be in a totally different situation, but that’s like saying if you took the moon out of the sky.”

If it proves durable for the long haul, 3D could be the rising tide that lifts all boats. But whether it can lift them high enough to overcome the whirlpool afflicting home entertainment remains to be seen.

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