Target, a Big DVD Seller, Warns Studios Over Download Pricing

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As Hollywood struggles to adapt to the digital era, a powerful constituency is making the transition tougher: major retailers who sell DVDs don't want to see new movie-downloading services gain an advantage in the eyes of consumers.

The latest sign of tension came in a letter Target Corp. sent to the major movie studios late last month. The big discounter expressed concern that new movie-downloading services will get a better deal from the studios on electronic copies of movies than Target gets on DVDs.

Target, which accounts for about 15% of the big studios' DVD sales in the U.S., said in the letter that it didn't object to competition but wanted "a level playing field." It went on to say that if it didn't receive what it considers to be equitable pricing from the studios it would reconsider its investment in the DVD business, suggesting the retailer might cut back on shelf space, promotional programs, signage and other aspects of marketing discs.

The sharply worded letter from Target President Gregg Steinhafel said that the chain had become aware that "some movie studios have made new-release movies available to download service providers at lower cost" than DVDs, allowing the downloaded movies to be sold to the public at lower prices.

A spokeswoman for Target said the company is trying to ensure that its business "is not put at a disadvantage."

The letter followed similar complaints from Wal-Mart Stores Inc. and comes just weeks after Apple Computer Inc. announced a deal with Walt Disney Co. to sell electronic copies of Disney movies online via Apple's iTunes Store for as little as $12.99 apiece for new titles, several dollars less than comparable DVD prices. Most of the retailers' concerns have been directed at Apple because other new entrants in movie downloading, like Amazon.com Inc., pay wholesale prices that are comparable to what DVD retailers pay.

Until now, most download services also have sold movies at prices in line with, or even slightly higher than, DVDs, posing little threat to conventional retailers. But Apple's cut-rate pricing, along with its considerable marketing clout, has alarmed those retailers, even as some of them contemplate launching download services of their own.

Relations with Target and other DVD retailers are likely to affect how quickly the big studios move to digital downloading, and at what price. If the big chains succeed in winning lower wholesale prices for DVDs, consumer prices could drop somewhat, although the studios are reluctant to give much ground in this area.

Consumers could suffer, however, if Target and its rivals become unhappy enough to scale back their DVD orders, possibly leading to shortages of some titles. Such action wouldn't be unprecedented. Angry at Disney's deal late last year to sell TV programming through iTunes, Wal-Mart temporarily refused to carry DVDs of the Disney Channel movie "High School Musical," a best seller.

Wal-Mart -- the nation's biggest DVD retailer, with as much as 40% of the market for big-studio DVDs -- sent a top executive to Hollywood to convey its misgiving, say people familiar with the situation. However, Wal-Mart, a big seller of Apple's iPod digital media player, softened its stance after Apple Chief Executive Steve Jobs complained in a telephone call to Wal-Mart Chief Executive Lee Scott about what he considered to be Wal-Mart's anticompetitive behavior, say people with knowledge of the talks. Fearful of possible legal ramifications, Wal-Mart executives called studio executives and told them Wal-Mart recognized the studios could pursue whatever sales channels they wished, these people say.

"Our concern is to provide customers with the very best value," said a Wal-Mart spokeswoman, who declined to comment on specific conversations. "We are continuously looking at new ways to do that."

The studios, people familiar with the situation say, are eager to put off any escalation of the pricing battle until after the important holiday sales season for DVDs. People familiar with the situation say that Apple, too, believes it probably will have to wait until after the holiday season to bring other studios behind Disney into the iTunes fold.

The tensions underscore the tightrope studios must walk to avoid alienating the retailers that are crucial to their DVD business as they experiment with undeveloped, but promising, distribution channels. While DVDs remain a major revenue generator, sales have plateaued, and they face diminishing growth. Adams Media Research, Carmel, Calif., projects U.S. DVD sales this year at $16.4 billion.

Retailers like Target and Wal-Mart typically pay $17 or $18 wholesale for new-release DVDs. They typically sell them to the public at $16 to $19, often pricing them below cost to attract consumers into their stores. Retailers worry that consumers will quickly lose interest in DVDs if cheaper online versions of movies become widely available.

That's yet to happen in any major way, but Apple's iTunes, which movie executives say has been negotiating with the major studios for months, appears to have made a big step in that direction. Under its recent deal with Disney, electronic copies of new Disney movies cost consumers $12.99 if preordered or purchased in the first week of release, or $14.99 after the first week of release. People familiar with the matter say Apple pays Disney a wholesale price of about $14.50 per movie.

The online store, which began selling Disney movies last month, has reported strong sales of Disney movie titles -- 125,000 in the first week alone. The studios are wary of letting iTunes achieve the same dominance in digital movie sales as it has in digital music sales.

Concerned about its DVD business, Wal-Mart swung into action as soon as it got wind of Apple's negotiations with the movie studios. Wal-Mart executives warned them that if iTunes won low wholesale prices for digital movies, Wal-Mart wanted a break on wholesale prices too, according to people familiar with the situation.

The prospect of angering Wal-Mart partly explains why only one studio, Disney, is so far offering movies via iTunes. Mr. Jobs, Apple's CEO, is Disney's largest individual shareholder and he became a member of the company's board after selling Pixar Animation Studios to the media giant earlier this year.

The movie studios themselves are equally wary of undercutting the DVD business. Lowering wholesale prices for DVDs would hit studio revenue hard, and studios don't want to go that route. At the same time, they have high hopes for online distribution because of its low costs. The studios worry that, at the wholesale prices Apple has asked for, most of that benefit would disappear.

Studios have reminded Wal-Mart that it stands to benefit from online movie distribution considerably through rising sales of video iPods and other similar portable video players in its stores. And Wal-Mart is planning its own digital movie store, which it will likely roll out in coming weeks, people familiar with the situation say.

Target, however, isn't ready to roll out an online movie store, and so has little interest in encouraging the studios to expand digital distribution. To try to smooth Target's ruffled feathers, Bob Chapek, Disney's president of home entertainment, and Pat Fitzgerald, executive vice president of sales, flew to Minneapolis to meet with Target executives last week.

The duo reiterated that digital distribution was a very small part of the movie business that didn't yet appeal to mainstream consumers, according to a person familiar with the conversation. They also stressed that TV titles sold on iTunes, including "Lost" and "Desperate Housewives," remain among the top-selling DVD titles, indicating that online sales currently expand the overall market rather than cut into DVD sales.

Cultivating a new distribution platform "is always risky, because you don't know if the new one is worth the pursuit of it, upsetting your relationship with the great customers of today," says Tom Adams, president of Adams Media Research. But studios have managed it before, he says, for example, embracing videocassettes in the 1980s despite resistance from pay-television businesses.

In fact, the current transition to digital may be easier in many ways, because many of the traditional retailers that are balking are also planning to open their digital download services eventually, giving them a stake in a successful outcome. However, Mr. Adams expects the shift to digital will be slow, projecting that even five years from now digital sales will still amount to less than 10% of physical DVD sales.



	October 9, 2006