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Online DVD Rental: Behind the curtains with Madhouse

Written by: Vivek Garg

On Jan 9th, 2007

[Update: Madhouse has given a special discount code for our readers. Details at the end of the post]

A lot has been written about online DVD rental business in India and Madhouse being one of the earliest player in the sector, it’s getting buzz everywhere. Seventymm is the poster child of the sector with a funding of $7 million dollars. Madhouse recently closed an angel round of $228000 and looking for more. We sat down with Nandini Hirianniah and Ankur Agrawal, the cofounders of Madhouse to learn the tricks of the trade. Instead of writing directly about Madhouse which already has been discussed several times, we will try to learn the challenges, business process and state of the sector taking Madhouse as our case study.

Start of DVD rental business in India: Most widespread means of watching movies at home is either VCDs or tapes. Consumer appetite for free and cheap content and lack of attention to quality makes it hard to get good quality DVD movies at local rental stores. Also limited shelf space makes it hard to cater to the consumer looking outside of popular bollywood flicks. Success of players like Netflix in USA makes it a known business model. These are precisely the reasons why Madhouse entered this business and I won’t be surprised if others did for the same reason too. Madhouse started this service in May 2005 and they supported this business without funding for almost 1.5 year.

Business Goal: Since movie rental is a subscription business, growth in number of subscribers in one area + growth in numbers of areas served would bring success provided the subscriber acquisition cost (SAC) + cost of keeping the subscriber (churn) + cost of serving the subscriber (COGS) < revenue generated per subscriber (ARPU). This is a greatly simplified picture but I like looking at it with this basic goal. Madhouse wouldn’t give us these numbers but they did mention that they are keeping an eye on their churn. They could keep it constant and even managed to reduce it over time after learning from the customer feedback and by introducing new schemes. I think there is a real lesson here. Understand why your customers are leaving you and act on it.

VCs waiting on the sidelines: We have said this before in earlier post that VCs in India are sitting at the sidelines with their money waiting for the traction in various markets. Madhouse also gave us a similar picture. According to them VCs are going to wait to see how they use their angel money. Some of the VCs think that Seventymm has already got a huge amount of money and this is a winner takes all market. Madhouse also told us that they are looking to increase the depth in the existing markets they serve instead of spreading too thin by expanding immediately. This will mean that they have to go beyond the early adopters of DVD rental business. I think this is a really good way to show to a VC that they are capable of gaining majority share but this also means that they lose the early movers advantage in other areas. What would you do in this case? Madhouse also suggested that VCs typically want to invest into businesses with 10X returns in 5-7 years and some of them don’t see the DVD rental as one. Other concerns raised were logistics and piracy and investors are still skeptical about the licensing and revenue deals with production houses.

Crossing the chasm: Everett Rogers theorized that innovations would spread through society in an S curve, as the early adopters select the technology first, followed by the majority, until a technology or innovation is common. We can think of the current DVD rental business at early adopter stage and it is yet to be seen if we can reach majority. According to Moore, the marketer should focus on one group of customers at a time, using each group as a base for marketing to the next group. The most difficult step is making the transition between visionaries (early adopters) and pragmatists (early majority). This is the chasm that he refers to and it will be interesting to see how it applies in this scenario. Madhouse agreed that most of their customers are early adopters and they are not doing any mass marketing as yet.

Customer, Customer, Customer: Educating customers is tough. Madhouse is not trying to educate customers rather they are trying to gobble up as many customers as possible before they hit the chasm. Their existing markets are Delhi and Chandigarh and they are taking these markets as good learning experience. They have learnt about the consumer habits about watching their movies as soon as they get it. They think 1 on 1 communication works best instead of mass advertising. They cannot stress enough about the quality of movies but they experience tough time explaining to average Joe why DVDs are better than VCDs. Madhouse says it is too soon to say what percentage of customers is with which company. In fact they are working together with some of their competitors to establish this business in the minds of people. When asked about their biggest challenge, Madhouse rightly noted that it is acquiring customers.

Moat and Barrier to entry: What are the differentiating factors for a DVD rental business? What would prevent your competitor from stealing your customers?
-I think exclusive licensing or innovative licensing methods with the publishers and production houses are certainly one of them. Madhouse licensing structure with various publishers includes flat payment per title for unlimited rental for the entire year. They also mention free licensing if they buy the DVD. To reduce this cost they are also thinking about revenue sharing deals. Primary goal here is to reduce capital cost with increased availability of titles.
-Low cost and a large scale distribution network. This can become a true moat once companies go national. Madhouse is trying to build their own.
-Technology for online recommendation and title queuing algorithm. Getting this system right is very important. Madhouse has tied up with NetKode, the company that manages technology for Hollywoodclicks.com, biggest DVD retailer in Singapore.
-Offline presence: madhouse is trying to position itself as movie rental service in their users mind instead of web company. This is why they put emphasis on interacting one to one with their customers. They will also try to achieve this by increasing their offline presence. I would like to remind our readers that one of our predictions for 2007 was that DVD rental companies will come up with offline presence and Madhouse is the first company that is doing this. They have introduced a concept of Movie point. These are existing retail stores that will agree to become DVD return outlets. Slowly they can expand these channels as pickup points. This will create indirect channels at reduced or fixed SAC targeting customers who are not going online. This is important as reverse logistic (returning DVDs) makes a big chunk of operating cost for Madhouse.

Milking the cow: Kishore Biyani of Pantaloon recently said “The money is in the peripheral activities; it’s never in the retail itself. It’s the power of retail that gets you the money; it’s never the transaction that gets you the money.” We think that once a transaction based system is set up, one can do different things to milk their setup. What can DVD rental business do? Some of the ideas we could think of
-Use DVD packaging/labels for ad distribution
-Sell merchandising related to the movies being rented like posters, shirts and coffee mugs.
-Outsource their distribution network for delivering other internet purchases.
Can you give us more ideas how Madhouse can make money?

Competition: We did an earlier post on various ways of distributing media and how online streaming could be a potential disruption to DVD rental. I would like to add an interesting quote on that. “if you carry a 4.7-gigabyte DVD down a ten-meter-long hallway at one meter per second, you’ve effectively “transmitted” the data on that disc at more than 3,700 megabits per second–a speed home networks won’t be reaching for a long time.”

Madhouse team has agreed to answer any direct questions that you have for them about their business. Feel free to leave them as a comment to this post.

[Update] They also have a special promotion for our readers. Subscribe to any of the Madhouse subscription plans and get a 10% discount when you use the promotion code “ileher”. Have fun renting.

Sphere: Related Content

Entry Filed under: DVD rental, Venture capital, hollywoodclicks, madhouse, marketing, media distribution, movie point, movies, netkode, online rental, seventymm

18 Responses Add your own

1. Madhur said on January 10th, 2007 at 3:12 am

Vivek, this is an excellent case study. One interesting factoid that might have played a role in SeventyMM getting funded is that supposedly Eric Mayer, one of the co-founders of Netflix is on its advisory panel. So getting an industry veteran in the board could be one of the ways to lure investors.
2. Tricks of the trade at Blogbharti said on January 10th, 2007 at 10:03 am

[...] In a comprehensive post, iLeher talks to the co-founders of online DVD rental outfit Madhouse and details the tricks of the trade. Delhi-based Madhouse recently received venture capital funding of US$228K (Rs1crore), which comes close on the heels of Seventymm, another online DVD rental, receiving VC funding of US$7m. Posted by BA [...]
3. Rajesh R K said on January 10th, 2007 at 10:43 am

Excellent analysis my friend.

I have always looked a place in Pune (this is around 4 years back) where I could get the equivalent of the Tartan Asia Extreme Series in India. Best of luck for to both SeventyMM and Madhouse (and all the other guys involved).

Guess what will make a difference here is the segmentation. If u can find a segment who want to watch Koroshiya Ichi (with the voiceovers), then it makes sense.

And how are you guys planning to handle people who are going to Torrent the movies off the Internet. I guess at 50kbps a 700 MB divx rip takes around 4/5 hours to download.

Anyway, I would love to see you guys do something with http://www.imdb.com, probably organise a DVD movie festival in Delhi/Mumbai where the concept can go through.

Sorry for the onanism..
4. Nari Kannan said on January 10th, 2007 at 8:06 pm

I have watched with great interest how BlockBuster completely ignored Netflix when it first came out and totally underestimated the power of the slogan “No More Late Fees” till it was too late. Now they are scrambling to try this and that but the cat is out of the bag and it is very hard to catch up.

NetFlix’s power was in figuring out that the new and growing format of DVDs provided a simpler way of sending movies to someone - by mail.

In India, the power is in the courier services available - practically by next day from any corner to any corner of India.
It is easier if it is local but distance is not a problem.

One of the things blocking many companies like Madhouse or SeventyMM or E-Commerce in India is the slow penetration of DSL or any broad band. Most internet users still use Dial-up at home and every call is charged. When DSL lines reach rs200 or less and you are not charged for every call and you can leave your computer logged in permanently, all of these businesses and E-Commerce will just explode.

Right now Travel sites, DVD rental sites are all primarily Urban, “login from work”, high income professionals. When the above problems are addressed that’s when it will move from early adopters and office users to people at home! An interesting study revealed that even in urban areas in India only about 50% of the wives work and the percentages are much much less in rural areas. But Boy! When they have a meaningful broadband connection that is left on all the time and they are home, all of these services and e-commerce will just explode!

Just my observations, spending a month or so every couple fo months in India, upclose. Sometimes the hype is overblown but the potential is there and it is always a bit slower in India than we think or hope! But India surprises everyone all the time!
5. Vivek Garg said on January 11th, 2007 at 6:56 am

Nari, I am not really sure if broadband penetration will give DVD rental any significant boost. Online streaming, yes I agree. As I mention in the post, Madhouse is trying to create various channels to reach out customer to deliver movies at home. And Internet is one of them.

Rajesh, I agree with you that torrent downloading can put a dent in DVD rental business but I still think there will be plenty more customers who would appreciate geting a DVD at home and plug and play in their living room.

Madhouse team can provide more accurate description of what they think about these issues.
6. Ravi Venkatraman said on January 11th, 2007 at 1:50 pm

Congratulations to the Madhouse Team.

I understand that their core business is to Rent DVD.
Is there any plan to sell
a) New DVD (not necessarily new movies)
b) Previewed DVD
This could be a great source of revenue. Initially, when the movies are released one might need 100s of DVD, but over a period one may need just 20 -30 in the inventory. The rest can either be sold as previewed or given to the members for free every 12 months.
7. Rajan said on January 12th, 2007 at 3:07 pm

Hi,

People are interested to see recent films than older one. How DVD rental companies can takeover these obstacles?

thanks&regards
Rajan
8. Vivek Garg said on January 14th, 2007 at 9:44 pm

New movies and old movies market coexist. Like tapes, DVD is an extended ecosystem for the industry. Producers invest in movie for returns in following order.

1. people watching them in theatres - box office returns
2. people watching at home and collect them in their library. Also people who miss it in theatres watch it at home.
3. VOD, pay per view and streaming online.

Studios control the timing of the availability of the movie so that these models do not collide with each other. Recently increasing DVD revenues are making this a chicken and egg problem for studios. If they get the DVD out sooner they kill the box office revenue, the very reason they make these movies.

here is an interesting article on tihs -
http://news.com.com/Wheres+the+iTunes+for+movies/2100-1025_3-5772286.html
9. DesiPundit » Archives » DVD Rentals said on January 14th, 2007 at 11:08 pm

[...] ileher has an interesting discussion on the DVD rental industry in India with Madhouse as a test case. They are also offering a discount coupon for Madhouse. [...]
10. Shashikant said on January 15th, 2007 at 11:25 am

Very detailed analysis of the rental business! But, here is the catch. Moser Baer is planning to sell film DVDs at Rs 34. If they succee, they will effectively wipe out the video rental business.

[Shameless self-promotion]
My post about the same.
[/Shameless self-promotion]
11. Ankur Agrawal said on January 15th, 2007 at 12:39 pm

Hi Everyone, Thanks for the comments and questions. I think I agree with Vivek’s reasoning.
Here’s our take:
1. On competition from internet downloads (via Torrent or other technologies): We think that internet is an important medium, and we are closely tracking global developments in this space, but we think that it will be at least a few years before movie downloads starts getting enough users. (There will always be some users downloading over the internet, such as in universities, but that number is currently small)We plan on offering content to our users over the platform they want, once the platform matures a little.

2. Our dependence on broadband penetration: Madhouse is actually a movie rental company, not an online movie rental company. We have lots of customers who communicate with us over the phone, not the web. We strongly believe that internet only is not a viable strategy for a business like ours. Therefore internet penetration does not effect us a lot.

3. Selling DVDs. We are looking at multiple ways of reducing cost of content for us, and sales of used DVDs is one option we are considering.

4. Demand skew towards new movies: Yes, new movies have a stronger demand than older ones. Again, we are working on a number of initiatives that help us work with that. A lot of them are operational in nature, and some are strategic. Over time, we have realised that there are some unique aspects of the Indian market structure that help us address this ‘problem’. Of course, those aspects will need to stay confidential

Ankur
(COO, Madhouse)
12. mahe said on January 19th, 2007 at 3:30 pm

[People are interested to see recent films than older one...]..Rajan

I beg to differ with rajan on this point..i am an example of a customer who would sit at the neighbourhood dvd store browsing thro that long list of films to pick that one classic hollywood film i last heard of. and this happeded only when my PC graduated from a VCD rom to a DVD rom..i think there would be a lot of people like me who would want to pick an old flick…infact i am waiting for one such online rental service to start in hyderabad..
13. Vivek Garg said on January 20th, 2007 at 7:05 pm

I agree Mahe. Online DVD rental totally fits the Long tail model.
14. alok sharma said on January 24th, 2007 at 10:10 pm

Hey,

Any information on the
1. number of customers they already have
2. the rate at which they are adding new customers

I think clarity on the above facts will put certain doubts to rest or may be validate them (as the case may be)
15. vivek garg said on January 26th, 2007 at 12:52 am

Madhouse did tell us these numbers but we were asked not to disclose them. I will let Ankur answer this if he wants to.
16. vijay said on January 29th, 2007 at 5:45 pm

rent-a-movie definitely has a potential as far as tradition of movie watching in india goes.

But going ahead theres a twist in tail here which most of this players should not overlook. with bandwidth prices going down, mobile population and capability going up and a strong multiplex culture coming up, how easy all this ventures will find to break even. Even issue is with target segments here as there behaviour changes very rapidly so do business will have to adjust here.

Few things are required as far as our subcontinet goes with a service like this which definitely has potential.
17. vijay kurhade said on March 26th, 2007 at 6:34 am

as per one concern earlier, production houses will start selling cheaper content, like moserbaer has started selling recorded movie dvd’s for rs 39 & vcds for rs 29 that could be a concern for renta movie kind of services.
18. iLeher » Chat with the founder and CEO of Seventymm Catching the Internet Wave in India said on April 22nd, 2007 at 5:22 am

[...] Bollywood is big. It produces more movies than Hollywood. It sells more tickets worldwide compared to Hollywood. It has more more than double the annual growth rate compared to Hollywood. It was only a matter time that someone took notice of this and did an Indian version of Netflix, the online DVD rental service. Well as it turns out, several did. Seventymm is one of the largest and most VC funded players in this space. We profiled another company Madhouse.in few months back on iLeher. There are several others trying to make a mark in this seemingly lucrative space. And just when you thought the market is getting saturated, the Indian behemoth Reliance announced its entry in this space with BigFlicks.com. Did someone say bubble? Well we’ll see who (perhaps there is room for more than one?) emerges out as the winner but the activity in this space is peaking because of combination of several factors including growth in Internet penetration and usage, growth in the installed base of DVD players and burgeoning venture funding scene in India. [...]

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