Will 'Burn On Demand' Eventually Save Blockbuster?

Last week, Blockbuster (BBI) made a pretty big splash after it announced that it was going to support Blu-Ray exclusively at its 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 its 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 its test stores were choosing Blu-Ray content. Sooner or later Blockbuster was going to have to choose a format and by doing it publicly, it was able to control how that information got out. Irrespective of its motivation, the move was smart on many levels and helped Sony (SNE) 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 chose its customers' 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 (MOVI) 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 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, then 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 its 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 its 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. It 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 its real estate and improve customer selection at the same time.

For Blockbuster the stakes are huge.

Unfortunately, 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 connected to the licensing of formats. Last December, things looked promising, in that we might be witnessing the birth of this technology.

Time Warner (TWX) CEO Dick Parsons said that 2007 would see the introduction of burn on demand technology for its retail partners, the DVD forum even “approved” a standard for the DRM, and in anticipation of the launch, Sonic solutions (SNIC) went as far as to announce that it was 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 its burn on demand ambitions, there have been hints it has had its eyes set on this target. Earlier this month, Lions Gate’s (LGF) CEO Jon Feltheimer said that the company had digital distribution agreements in place with Best Buy (BBY) 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 ongoing 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 its 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 it's willing to ostracize its customers in order to maintain its 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 Wednesday’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 (RIMG) also issued a press release where it mentioned its 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 it's 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 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 its 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 Wednesday, 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 its own PS3 with a forced Blu-Ray “upgrade,” I wouldn’t put it past the company to try and use its 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 its support for Blu-Ray may have included a little tit for tat in getting the deal done. 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.