Proposed acquisition by Blockbuster Entertainment Ltd (Blockbuster) of certain assets of Apollo Video Film Hire (Apollo)

No. ME/1113/01

A report under section 125(4) of the Fair Trading Act 1973 on the advice of the Deputy Director General of Fair Trading, given on 11 April 2001, to the Secretary of State for Trade and Industry under section 76 of the Act

Jurisdiction

The proposed merger satisfies the share of supply test of the FTA in respect of the supply of videocassettes for rental.

The parties

Blockbuster Entertainment Ltd supplies videocassettes and DVDs for rental. It also offers for sale new and ex-rental videos from a chain of 672 stores and vending machines in the UK. In the year ended 31 December 1999, Blockbuster reported operating profits of £13.4m on turnover of £203m. Gross assets as at that date were £97m.

Apollo Video Film Hire Ltd is in the business of rental of videocassettes and DVDs. It operates from a chain of 146 stores nation-wide of which 41 are wholly owned by it; the remainder operate under franchise arrangements. In the year ended 30 June 1999, Apollo reported operating profits of £0.4m on turnover of £10.9m. Gross assets as at that date were £4m.

The transaction

The transaction involves the purchase by Blockbuster of Apollo's 41 wholly owned outlets - of which 30 are located in or around the London area - with the remaining 105 franchised outlets continuing to operate independently and in competition with Blockbuster.

Assessment

Relevant markets

The parties are in the business of renting out films on videos and DVDs from stores in the UK. Some stores also offer films on DVD or video for sale (called video retail) either as new or previously rented out.

Whilst competition from other distribution channels for films - such as cinema and television - is not considered to be in the same market, Blockbuster contend that the competitive constraint from such sources was strong enough to constrain video outlets from exercising any market power. Film releases follow a fairly established pattern of distribution with the theatrical release signalling the start of the process. This is followed by release for video rental about 6 months later (the video rental 'window') and, 4 to 6 months after this, release for retail sale and for exhibition on Pay-Per-View (PPV) television. The movie would be released for subscription television after a further 4-6 months and finally, about 2 years after the theatrical release, make a debut on terrestrial television. There has been a tendency recently within the industry to reduce the period of the video rental 'window' so bringing forward the release of a video for retail sale.

Geographic Markets

The supply of videos (and DVDs) for rental is essentially a national market given the language and film certification requirements. All the video rental chains appear to negotiate and buy their requirements nationally. On the demand side, however, video rental is essentially a local market with customers unwilling to travel more than 1-2 miles to rent a video. This distance may be reduced in major urban areas.

Horizontal issues

At the national level, Blockbuster is the largest chain of video rental stores in the UK. It currently has 672 stores and accounts for an estimated 28% by volume of the rental market in 2000. The addition of the 41 Apollo stores would increase Blockbuster's market share by approximately 1.5%, on the basis of the number of rentals.

However, there is an argument that the market may segment between specialist rental stores and non-specialist outlets. If specialist rental stores are considered to be in a separate relevant market from convenience stores and other non-specialist rental outlets, because of the range and copy depth they hold, then Blockbuster would have 34% market share and the increment is about 2% (see note 1).

The issue raised by this relatively modest increase in national market share is whether it would further increase Blockbuster's buying power. Blockbuster is already able to negotiate significant discounts on the price of videos for rental from distributors on the basis of the high volumes that it buys. This benefit would be extended to the Apollo stores that it acquires. However, the extent to which this benefit will be passed on to the consumer may, given Blockbuster's ability to vary the price it charges for renting videos, be determined by the extent of competition at the local level.

Local issues

A single video rental store in a given location will create its own demand and will be able to price up to the point at which other entertainment products/services are seen as substitutable by consumers. If more than one video store is located in a particular area, they appear to compete directly on rental price and rental period as well as other factors such as video availability and product range. Thus the loss of competition at the local level may lead to higher prices and/or reduced availability.

Blockbuster contend that the typical catchment area for its outlets is a radius of 1.5 miles from the store. Using that basis, it identifies the areas of overlap between each of the Apollo stores to be transferred and the stores of Blockbuster and competitors within such a radius. There may be some sensitivities in this approach since it may be that in some areas (i.e. London) a 1.5 mile radius is too wide while in others areas it may be too narrow. Also, while 1.5 miles may be a reasonable catchment for Blockbuster stores, which tend to be larger stores, it may be too wide for Apollo and other competitors. For example, Apollo had recently opened a store in Brixton Road, SW9, within 1.5 miles of 3 of its existing stores.

However, an analysis on this basis of the proposed acquisition at the local level shows that in 10 of the 41 Apollo sites, there is no overlap between the parties and in a further 2 the only overlap is provided by a Blockbuster vending machine (vending machines offer a much reduced choice). In 13 of the remaining 29 areas, the parties will have 50% or more of the specialist rental stores within the 1.5 mile radii identified by Blockbuster. Of these 13, six of the radii overlap to some extent in an area of south west (see note 2) London where Apollo is the main competitor to Blockbuster. In another 3 local areas bordering south London the merger would also significantly reduce competition at the local level.

In areas where Apollo is currently Blockbuster's strongest competitor, the merger would reduce the competitive constraint upon Blockbuster, both in terms of the lower rental charges and different rental periods that Apollo offers. Blockbuster appears to vary its prices according to local conditions depending on competition and demographics and as between its highest price point of £3.75 for Premium New Releases and lower price points (£3.50, £3.25, £3, £2.75, and £2.50) some of which apply for a 2-night rental period. Apollo appears to offer films at the lower single night rental of £3.25, before switching to a 3-night rental charge of £2.

Barriers to entry

There are few barriers to entry. Other than finding a suitable retail outlet, the cost of setting up a video store is estimated to be as low as £10,000. However, while single site specialist stores might be able to compete on price - because of lower overheads and greater rentals per copy - they would not be able to compete on availability and product range. Blockbuster's size and reputation could also act as a barrier to entry.

Buyer power

Blockbuster accounts for up [details omitted] of UK sales for some movie distributors. Volume discounts are already a significant feature of the relationship between these two participants in the market. A further increase in Blockbuster's size could enable it to obtain more favourable terms from distributors. However, given the nature of the video rental business, there is a degree of mutual dependence between large movie distributors and video rental outlets. A positive effect of Blockbuster's buyer power is that it enables Blockbuster to have more copies of popular films available for the general public.

Third party views

Suppliers (film distributors) expressed some concern about Blockbuster's existing market power and the increase arising from this merger. Competing specialist video rental companies were, however, divided. Some expressed concerns about the loss of local competition and increased barriers to entry, particularly to the London market, whereas others took the view that Blockbuster was already dominant and the merger would not change that. No consumers or consumer groups raised any concerns about the merger.

Conclusions and recommendations

There is a concern that the transaction will increase Blockbuster's bargaining power with film distributors. However, the increment at the national level is relatively modest. There are potential benefits arising from the merger in that Blockbuster would be able to extend its buyer power (and associated copy depth) to the acquired Apollo stores. However, the extent to which these benefits will be passed on to the consumer may depend on there being active competition at the local level.

At the local level, the transaction will have the effect of removing the major competitor to Blockbuster in south London and the South East of England-where the majority of Apollo's 41 outlets are located. Blockbuster's position in this area would be further enhanced by the fact that its major national competitors have only a limited presence here. The merger would, thus, significantly reduce competition within a number of local markets.

While there are arguments for and against reference, the balancing of potential consumer benefits as against the potential loss of competition is usually considered to be a matter for Competition Commission.

Undertakings in lieu of reference

There are adverse effects arising from the combination of the increase in market power at the national level, combined with a loss of competition within a number of local markets. It might be possible to reduce the loss of competition at the local level by seeking undertakings from Blockbuster not to acquire those Apollo stores which give rise to such concerns. Blockbuster has indicated a willingness to consider such undertakings although the number of outlets that might be excluded have not been discussed. However, this would not necessarily remove the concerns of suppliers about the increase in market power.

Recommendation

I therefore conclude and recommend that you refer the merger to the Competition Commission.

Notes

1. OFT estimate from core figures obtained from BVA Handbook for 2000.
2. Corrected by the parties to read 'south east'.

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