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THE HOLLYWOOD SHUFFLE

Two camps have emerged within the grocery channel for those involved in marketing home entertainment these days -- the risk takers and those that have become disenchanted with Hollywood's glitz.It may be true that in 1999 nearly four in 10 supermarkets have set up more video departments (38.2%), half have deepened their inventory (47.3%), one-third advertise and promote video more (32.7%), and nearly

Two camps have emerged within the grocery channel for those involved in marketing home entertainment these days -- the risk takers and those that have become disenchanted with Hollywood's glitz.

It may be true that in 1999 nearly four in 10 supermarkets have set up more video departments (38.2%), half have deepened their inventory (47.3%), one-third advertise and promote video more (32.7%), and nearly one in four found enough room between them and their competition to even raise prices (23.6%).

Industry optimists can point to these figures in the Ninth Annual Supermarket News State of the Industry Video Report, as signs that the trade class is vibrant and building momentum in a glamour-generating department that lifts customers from the drudgery of shopping and consistently creates repeat visits.

They'd be partly right.

Supermarkets are clearly of two minds when it comes to video.

In one camp are chains moving fast to carve home entertainment themes in their stores. They're the ones twinning video, DVD, games and music, and target marketing to frequent renters and sell-through buyers, in attempts to leverage their decisive edge in customer counts and store-visit frequency to cement a loyal following and build incremental performance.

What makes these efforts click with consumers is an in-store staff that knows the products and let their enthusiasm show because they're incentivized for building rental and sell-through volume. Paired with this is merchandising that brings the glitz of Hollywood into food stores, and consumer-friendly policies such as extended rental periods and value promotions.

That's Home Entertainment!

Cutting Their Losses

There's a growing body of food chains, however, that decided to vacate entirely or downsize their exposure after several trends conspired in 1999 to make the video business less attractive. They cited labor cost and space constraints, well-honed marketing and buying strategies by video-specialty chains which they find tough to match, complex distribution and return programs from some studios and distributors, and the lack of hot new theatrical titles that would create consumer frenzy in their aisles.

The result: The total rental and sell-through revenues in supermarkets slid about 3% to $2.24 billion in the same period, as food chains lost ground to specialty chains such as Blockbuster, Hollywood Video and The Movie Gallery, according to survey findings. Video rental revenues declined by 5.2% in 1999 to $1.20 billion, and sell-through revenues edged down by 1.9% to $1.04 billion. Moreover, video rental and sell-through margins took their third straight yearly hits, according to video buyers, category managers and senior chain marketing and merchandising executives surveyed at 66 supermarket chains.

They detailed how rental margins fell to their lowest point ever -- 28.7% -- down considerably from 31.2% in the prior year. Sell-through margins also fell to 14.7%, down from 17.4% in 1998. This compares unfavorably against historic department performance as well as most general merchandise sold in the stores, which is priced to yield in the 30s range.

SN retained Model Resources Market Research, Syosset, N.Y., to conduct its Ninth Annual State-of-the-Industry Video Report, covering 1999 operations in supermarkets. Between March and May 2000, the research firm interviewed video buyers, category managers, divisional merchandise managers and general merchandise managers of supermarket chains and regional independents, as well as executives of major distributors, to secure responses from 66 retail companies currently engaged in the marketing and merchandising of videos. These companies operated 9,899 stores in 1999. The results reflect video rentals at 3,454 supermarkets and sell-through activity at 5,662 stores. Total annual dollar volume for the retailers responding to the survey exceeded $100 billion in 1999.

Entertainment Hits Road Bump

All told, the unique combination of events in 1999 rang a low point in supermarkets, from which they can and must rebound, said industry sources.

The Video Software Dealers Association, Encino, Calif., representing video retailers, suffered turbulence of its own last year with the resignation of its president Jeffrey Eves, who was heavily criticized for not doing enough to represent the interests of the majority membership -- the independents -- against the large specialty chains. Supermarkets are considered on the same playing field as the independents as far as competing with the larger chains that are accused of reaping more favorable marketing programs from the studios.

"The trade class did reach a low in June of 1999," conceded Bill Bryant, vice president, sales, grocery and drug, at La Vergne, Tenn.-based Ingram Entertainment. "However, VSDA meetings were productive in July of 1999, and senior management from several studios actually flew to the headquarters of several supermarket chains immediately after VSDA to find out more about the problems supermarkets were facing in the business.

"Programs were subsequently put in place that rejuvenated sales and profitability for those retailers that were willing to bring the category back to life," Bryant added. "Today, there are many success stories pertaining to supermarket rental departments that made a tremendous rebound during the past 10 months."

Overwhelmingly, supermarket executives survey respondents regard specialty video chains as their primary competition. Nearly nine in 10 (88.9%) said this, and just 7.4% cited other supermarkets while 3.7% believe it is mass merchants. That's not surprising, considering that Blockbuster has grown by more than 1,000 stores in the past three years, and Hollywood has expanded by more than 600 units in that time period.

Bryant further described how supermarket category managers have grown "less tolerant of weak programs and more bullish with programs that make sense. This has been a good step for the trade class to take," particularly in light of food stores' one-stop concept. In a previous SN consumer study, shoppers ranked video as their most preferred service department, ahead of banks and dry cleaning that often replace unprofitable video departments.

Indeed, David T. McConnell Jr., president of the General Merchandise Distributors Council, based in Colorado Springs, Colo., put his own exclamation point on the value of video in supermarkets, during a presentation on nonfood trends at the GMDC's General Merchandise Marketing Conference in Orlando, Fla., last month. "A number of chains have left the video business, acknowledging the strength of category killers. Yet it might be a better strategy to combine DVDs, full-price quality cameras and other related merchandise to create a total home entertainment solution, so people [who are already in your stores] don't have to go to Blockbuster or Hollywood Video."

There's no denying that 1999 was a trying year for supermarkets in video. Yet such low points start learning curves for the smart. And as successful contrarian stock investors are quick to point out, cyclical ebbs are the time to pour money into businesses one believes in.

One such video advocate is Tony Federico, vice president -- health and beauty care and nonfoods, at Asheville, N.C.-based Ingles Markets. He began re-signing his departments six months ago from video to media to "expand our horizon. We can't just be a video store concept," he stated. To that end, he has brought into adjacent physical areas consumer electronics, software, music CDs and cassettes, video games, VHS tapes and a book/magazine reading center. Six overhead monitors show videos and lure shoppers from throughout the store. "We've always had the product. Now we teamed the merchandise areas and have a true media center," he said, noting the revamp is already in six stores and will roll out to 25 more over the next 12 months.

That is just one example of home entertainment resiliency and innovation in many corners of the supermarket trade. Distributor sources also cite excellence in video rental programs at such geographically diverse chains as Reasor's, based in Tahlequah, Okla.; Coborn's in St. Cloud, Minn.; and K-VA-T Food City in Abingdon, Va.

It's clear from the SN survey findings that many chains continue to pursue video rental with vigor. Close to half the respondents (44%) deepened their video rental inventory, 38.2% established more departments and 34.5% lengthened rental periods to stay competitive in their offerings. The surge in DVD is evident in the figure that 75.6% of supermarkets established more DVD rental departments in 1999, 60% expanded space in existing stores, and 57.8% broadened their inventory.

Meanwhile, sell-through activity was also keen among responding chains: nearly four in ten (38.1%) set up more video sell-through departments, 59.4% set up more DVD sell-through departments, and 36% expanded the number of stores that sell games.

Also maintaining its video presence in close to 60 of its 140 stores, the Jackson, Miss.-based Jitney Jungle Stores of America prices new release rentals at $1.99 for two nights, "which is cheaper than the video stores but people don't always recognize we're a value," said Dave Wesloh, vice president, HBC and general merchandise. "It's hard to promote when it's not in all of your stores."

On an industrywide basis, supermarkets typically charge less than video specialty chains for video rentals. The average supermarket price edged up to $2.53 in 1999, compared to a total market average of $2.78.

"What's also hurt lately is the lack of blockbuster titles. There are very few, and the specialty chains keep a lot of that business. That gets us into a Catch-22," added Wesloh, describing a common quandary for supermarkets in video. "When the business is declining overall, you end up buying fewer copies of titles to minimize inventory investment and risk going out of stock, which clearly hurts with consumers.

"But the biggest hurt is what we do to ourselves internally. We're so intent on cutting labor costs in the stores that we don't make it easy for consumers to get in and out quickly. You'd think we could leverage the traffic and build video, but it goes back to staffing," he noted.

Meanwhile, Jeff Manning, group vice president, general merchandise, HBC and specialty at Oklahoma City-based Fleming Companies, pointed to "unfair cash flows" as a main difficulty for supermarkets in video. "Food stores can't compete with Blockbuster because that chain deals direct with studios, gets tapes cheap and doesn't have to pay for them until after they're renting them. That's how they can create all those massive displays and depth. We have to deal with distributors and pay their mark."

Moreover, Manning predicts that all forms of home entertainment -- video, DVD, gaming and music -- will be on demand within a few years, so he sees "just a few years left for retailers to capitalize. Retail will not be the way to deliver this in the long term."

Clearly, supermarket executives corroborate his views on cash management. Of nine types of copy-depth programs that prevail in the video industry, they gave a high score to just one: unconditional lower prices from studios. On a scale of one to five, with five being the most preferred type of program, respondents scored this a 4.24. Following were free goods programs (3.91), sell-through titles used for rental (3.87), multipacks (3.65) and lower prices based on goals (3.44).

Moreover, survey respondents cited the "cost of acquiring videos" and "confusing copy-depth programs" as two of their three greatest hurdles to setting effective departmental strategies. On a scale of 1 to 5, with 5 posing the greatest challenge, they scored these at 3.88 and 3.50.

Leveling Out the Field

If some of this commentary by supermarket executives seems excessively negative, consider the examples of video success at chains that have demonstrated top-down commitment, as well as a renewed vigor by suppliers to help food chains compete in this arena.

"Studios and game suppliers have leveled out the playing field during the last 12 months, viewing all retailers equally," noted Ingram's Bryant. "Supermarkets are an important part of the rental business, and studios are working diligently to assist them in their efforts to succeed. Many supermarkets now obtain between 12% and 15% of rental revenues from video games. This is quite an improvement compared to several years ago."

Indeed, the SN survey shows that supermarkets derive 11.2% of their department revenue from game rentals and 8.4% from game sell-through. The bigger contributors are video rental at 70.1% and video sell-through at 25.9%. These figures add up to more than 100% because many of the chains responding to the SN survey classify sell-through as part of general merchandise overall, and do not assign their percentages to the video department.

Kirk Kirkpatrick, vice president marketing, WaxWorks/VideoWorks, Owensboro, Ky., concurs with Bryant's assessment. "Most studios and video game suppliers are more interested in who they sell to than who we [as distributors] sell to. They just want us to sell a lot. They don't show favoritism to any trade class. The relationship exists between studios and distributors because most studios aren't set up to deliver to all stores simultaneously. The meat guy in the supermarket doesn't converse with the farmer. He deals with the slaughterhouse. The studio's job is to have big national advertising, and it's our job to get retailers product and marketing tools -- but it won't work unless supermarkets assign someone to oversee it."

Promotions and marketing themes are vital to success, he said, noting that Waxworks just produced a full-page history for in-store posting of the James Bond women. The history is a way to induce consumer interest in the female characters and the actresses who played them, as well as the entire movie series, including newer releases. The benefit to retailers is incremental rentals on older films the chains have long ago paid for. Kirkpatrick recalls hiring the Louisville Symphony Orchestra to perform outside of Kroger stores in that KMA when one of the "Star Wars" films came out on video. "Hollywood is excitement. It's good to have this in your arsenal," said Kirkpatrick.

In that way, video brings added value to supermarkets, he added. "Not everyone is wild about milk or bread, but they all have a favorite movie."

Moreover, Kirkpatrick sees a wide, clear path for supermarkets in video. "Mass merchants have a lot of traffic, but they don't rent, they only sell movies. Drug stores only sell, and they emphasize in-and-out promotions. Many on-line sites also get traffic, but they only sell. And video specialty stores don't have other reasons for people to go there. Only supermarkets rent and sell, with such high rates of customer visits. If video stores can be profitable just doing video, there's no reason supermarkets can't succeed. But they must treat video as a business within their business, with trained enthusiasts on staff and fun, effective promotions."

By blending ongoing conventional opportunities in video, Ingram's Bryant urged supermarkets to merchandise $9.98 and $14.98 suggested retail price sell-through video in a dedicated section within the main selling area of the store. "Many chains have successfully tested this concept and subsequently expanded catalog sell-through sections chainwide," he said, noting their high margins and substantial impulse sales.

Growth in DVD/Games

Kirkpatrick also said he is most excited by prospects for DVD and gaming. "DVD offers stunning video and audio that allows retailers to compete with any satellite signal. It is absolutely pristine, and it ties in so well with people buying large-screen television systems. It is also priced better than VHS tapes, with most less than $25 apiece. Let's take "The Matrix," for instance. To buy a VHS tape for rental when it came out would have been $65 or $70, but the DVD was $19. There are already 5 million DVD players in American homes, and 12 million if you count desktop and laptop computers, and that's growing," he said.

"DVD is growing faster than any other home entertainment entity in history, about eight to 10 times faster than compact discs, as player prices plummeted from $1,200 a year ago to about $200 today. If I were a retailer starting out, and had no video in my store yet, I'd just come out with DVD," said Kirkpatrick. "It costs less and I'd become known as the DVD center."

The success of DVD will be married to the explosion in gaming systems, as Sony's Playstation 2 is expected to penetrate households at the rate of 1 million households a month after it is introduced on Oct. 26. The console also plays DVDs.

So far, about two out of three supermarket chains or 68.2% of those surveyed said they offer DVD rentals and slightly less than half or 48.5% offer DVD sell-through. The gaming figures are roughly comparable, with 74.2% offering game rentals and 37.9% offering game sell-through.

But both are likely to rise as technology makes it easier and more pleasurable for consumers, and prices stabilize or fall. Shrewdly managed, this could create new vistas of opportunities for supermarkets, even in the face of satellite and cable entertainment-on-demand competition.