Why Hollywood Video failed

HWOOD1Why Hollywood Video failed: New technology and consumer fancy turn out the lights for Hollywood Video.

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New technology and consumer fancy turn out the lights for Hollywood Video.

In the only visible sign of a survival strategy, Movie Gallery recently closed 760 stores, including eight Hollywood Videos in Oregon. “I’ve heard nothing else about strategy,” says industry watcher Thomas Arnold. “Have you?”

They started showing up on the sidewalks in late winter, right out in front of the stores in Portland, Lake Oswego, Canby, Newberg, Salem, Wilsonville, Keizer and Sandy.

The sign wavers.

High schoolers with headphones and bored expressions; a tall, waving woman in gloves and hat; a gruff guy in blaze orange camo; each one holding or rocking or spinning the same six-foot sign advertising the final days of a Hollywood Video store.

“DVDs — three for $8.”

“All DVDs $2.99 or less.”

“Fixtures for sale.”

Yes, even the fixtures were for sale at some of the 760 stores that Hollywood’s parent company, Movie Gallery, began closing just after it announced in February that it was filing for Chapter 11 bankruptcy protection — for the second time in the past three years.

The move was hardly a surprising twist considering the turns that both Hollywood Video — founded in Southeast Portland in 1988 — and Movie Gallery, the Alabama video rental chain that acquired Hollywood in 2005 and moved its headquarters to Wilsonville in 2009, have endured over the past 10 years or so. There have been massive debts, economic swings and management missteps; technological battles and threats of hostile takeovers. The entire home video industry itself has morphed from brick-and-mortar rental stores to $1 rentals in grocery stores, video-on-demand services and unlimited DVDs every month for little more than the cost of renting a single movie from the neighborhood store.

Saddled with somewhere between $500 million and $1 billion in liabilities and clopping along with what many in the industry see as a dated business plan geared toward the rural south of 20 years ago, Movie Gallery had few options other than to try a sequel to its 2007 restructuring efforts. It’s hoping to emerge from bankruptcy a leaner outfit —it initially planned to close some 760 money-losing Hollywood Video, Movie Gallery and Game Crazy stores, leaving roughly 1,900 U.S. locations — but one that will still meet most of its customers’ demand primarily through retail locations.

Thousands of its more than 19,100 employees nationwide are expected to lose their jobs, including many Oregonians. In 2005, Hollywood employed 1,800 in Oregon, but those numbers have declined since Movie Gallery took over. Numerous store closings before and during the first bankruptcy — ultimately more than 1,000 were closed nationwide — erased an untold number jobs in the state, and in January 2009, more than 200 full-timers were cut from a Wilsonville distribution center. In the same month, Movie Gallery still reported employing 389 people at its Wilsonville headquarters.

“We intend to emerge from the reorganization process with a new and sustainable business model centered on a smaller base of profitable stores,” the company repeated throughout the restructuring information provided on its website. (Movie Gallery did not respond to repeated requests for comment on this story.)

But the prevailing sentiment that Movie Gallery and its Oregon-grown subsidiary Hollywood Video were living on borrowed time came to pass in early May, when the company announced it will liquidate its merchandise and close all stores.

“I’m surprised they’ve hung in as long as they have,” says Thomas Arnold, publisher and editor of the weekly trade publication Home Media Magazine. “There’s an old saying: change or die. And Movie Gallery hasn’t changed.”

hollywoodDespite its trials along the way, Hollywood Video has long held a place in the annals of successful businesses to emerge from the Beaver State. Mark Wattles, an aggressive Oregon entrepreneur, opened his very first video rental store, called Home Theater, on SE Powell Boulevard in Portland in 1988, a bustling and burgeoning time for the home entertainment scene. The next year, he changed the store’s name to Hollywood Video and set about an expansion aimed at giving the industry giant, Blockbuster, a run for its money.

And he did.

Hollywood grew through acquisitions and new stores, often in the same mostly urban retail centers as Blockbuster. Wattles took the company public in 1993, and Hollywood continued to grow, eventually topping out at the beginning of the new century with more than 2,000 Hollywood Video stores, 700 Game Crazy video game outlets and nearly $2 billion in annual sales — stats that made it the second-largest rental chain in the country behind Blockbuster.

Less well known, at least in these parts, is the story of Movie Gallery, Hollywood’s southern, more rural counterpart. Founded in Dothan, Ala., in 1985 by business partners Joe Malugen and Harrison Parrish — neither of whom even owned a VCR at the time they bought their first store — Movie Gallery grew at a faster clip than Hollywood, albeit in much smaller markets primarily in the American South. The company acquired small mom-and-pop outlets, built up a franchise base by entertaining prospective owners on a tour bus that once belonged to Jimmy Buffet and then went public in 1994.

Movie Gallery grew to almost 1,000 stores in 31 states by 1999 with annual revenue of $276 million, and by 2005, the year it acquired Hollywood Video, Movie Gallery had hit 2,500 stores.

Phenomenal success aside, both companies had taken some hits by the time of the acquisition. Most notably, Hollywood had teetered on the edge of bankruptcy thanks in part to an ill-fated $100 million attempt at online video retailing with the acquisition of Reel.com in 1999. Wattles, who now heads up Wattles Capital Management in Colorado and who also did not respond to requests for comment, orchestrated a rousing comeback for Hollywood that helped set the stage for the acquisition.

But by the early 2000s, bigger shifts in the home entertainment industry had already begun to have their way with the likes of Movie Gallery and Hollywood Video. For starters, major retailers like Wal-Mart entered the video-selling business, using cheap movies as loss leaders to pull customers into stores.

“That really began to change the fortunes dramatically for the rental chains,” Arnold says. “For a while, even the poorer, more rural areas were safe for the rental business, but then Wal-Mart came to the rural areas.”

Around the same time, Netflix, the California company that offers monthly movie rental subscriptions by mail, began to edge its way into the market with its lure of convenience and zero late fees. In 2003, Redbox, a video vending company that uses soda-machine-sized kiosks to rent DVDs for $1 a day, began sprouting up in grocery stores and fast-food restaurants. All the while, video-on-demand and online streaming services continued to multiply and offer consumers still more alternatives to the traditional video rental store.

While some of the rental chains, including Hollywood and Blockbuster, tried to compete by introducing their own subscription and online services, Movie Gallery stuck to its tried-and-true guns and in 2005 acquired Hollywood Video in a $1.2 billion deal that included $350 million worth of Hollywood’s debt. The deal gave Movie Gallery close to 4,500 retail locations.

“When everybody else was doing kiosks and mail and even digital, Movie Gallery did nothing, or even the opposite,” Arnold says. “It’s like we’re seeing all these electric cars and everybody’s going green, then somebody like Movie Gallery goes out and buys a second gas-guzzling SUV.”

In less than two years, weighted with debt and nearly immobile on the innovation side, Movie Gallery had filed for Chapter 11 and closed nearly 1,000 stores. Its one noteworthy effort at advancing a new technology was its January 2007 acquisition of a foundering digital movie service called MovieBeam for $10 million. The service failed to take off, and Movie Gallery sold it for $2 million a year later.

Market conditions continued to worsen even after Movie Gallery emerged from bankruptcy and moved its headquarters to Wilsonville in 2009. Not only has the recession hit the industry, but also mail, online and other content options continue to chip away at brick-and-mortar rentals. According to the Entertainment Merchants Association 2008 Annual Report on the Home Entertainment Industry, there were more than 21,100 brick-and-mortar video rental stores in the U.S. in 2006; by 2008, that number had fallen below 14,300.

“A lot of it is driven by the success of the DVD kiosks and Netflix,” says Edward Woo, an analyst with Wedbush Morgan Securities in Los Angeles specializing in media and entertainment. “Unfortunately it’s very bleak. [The brick-and-mortar store] is just not where people want to rent their movies anymore.”

In addition, investment bankers likely have taken Movie Gallery to the cleaners throughout the merger with Hollywood and its two bankruptcies, says Portland investment manager Bill Parish.

“At the end of the day, investment bankers have made spectacular money off all this,” he said. “They don’t have a prayer.”

In the wake of massive store closings, Hollywood Video hopes customers will migrate to the few remaining outlets in Oregon.

Beyond a smaller number of stores and new $1 rentals for members of its PowerPlay subscription service, there was little more than speculation about how Movie Gallery planned to emerge from its second bankruptcy.

“The creditors who seized them and brought them out the first time clearly had no idea what they were doing,” said Michael Pachter, another industry analyst at Wedbush.

There are promising new markets in the realm of Blu-ray and 3-D, and Movie Gallery had entered into trial agreements with several different digital kiosk companies, including Digiboo and Seattle’s MOD Systems, who offer digital movies that can be downloaded off in-store flat screen kiosks onto portable USB drives and SD memory cards.

“It’s really another way to revolutionize the brick-and-mortar video rental concept, so it’s showing some foresight on Movie Gallery’s part,” says Craig Parsons, a spokesman for Digiboo, which had planned to test up to 100 of its digital kiosks in Movie Gallery and Hollywood Video stores this year.

But the verdict is still out on whether the digital kiosk concept will appeal to consumers, more and more of whom can download content at home without having to head out and find a kiosk. Pachter calls the digital kiosk “the lamest thing I’ve ever seen” and compares it to FedEx’s Zap Mail faxing service of the 1980s, which flopped colossally within two years of its launch after fax machines became readily affordable.

Woo is also quick to point out that Netflix and Redbox are so far ahead in their particular niches of the business that Movie Gallery, a company not known as cutting-edge, would be hard-pressed to dent those markets at all with its own mail or streaming services.

In addition, Blockbuster has tried its hand at just about every alternative delivery method and is still near collapse. The video store giant, which operates more than 4,000 stores in the U.S., announced in mid-March that it was on the verge of Chapter 11 because of a massive debt load.

Another sliver of hope for Hollywood and other rental stores was to sign agreements with major studios giving rental stores and retailers exclusive rights to new releases for 28 to 45 days before they’re made available to Netflix and Redbox. (Warner Bros. Entertainment declined to comment and Sony Pictures did not respond to a request for comment.)

“That would be helpful, but again, I’m not sure that window will be enough to help them,” Woo said. “And I’m sure the studios are concerned about the financial situations of anyone they do business with.”

In the end, Pachter says consumers are going to go with the cheaper, more convenient option, even if that means sacrificing some choices.

When Hollywood Video failed to find a way to offer consumers what they wanted, the future of what was once one of Oregon’s most successful companies became just another piece of used-up material, falling down to the cutting-room floor.

UPDATE (May 3, 2010): Shortly after the publication of this story, Movie Gallery/Hollywood Video announced they will close all stores and liquidate all merchandise over the next several months. The editors rewrote several sections of the online version of this story to reflect that news, replacing hypothetical scenarios with updated realities.