Netflix & Walmart Illegally Cornering DVD Market?

Over the last few years, it’s been no secret that Netflix has become the dominant force for DVD by mail rentals. There may be plenty of other ways to watch films, but when it comes to renting through the mail, Netflix’s laser like focus has put them in the enviable position of being able to assert a large degree of control over the economics of their market. While there is nothing wrong with a company being so successful that they become the dominant player through skill, there are laws against abusing that power to prevent competition.

A few years ago, Wal-mart created a copycat DVD rental service in order to try and get their own piece of the DVD rental market. Their results were disastrous and despite significant financial and retail advantages, the service never caught on with consumers. Eventually, Wal-Mart realized that it was foolish to spend as much time and money focusing on such a small part of their core business, so they threw in the towel and essentially sold their membership base to Netflix. While we know that the agreement included some cross promotional advertising, the actual terms of the deal weren’t ever publicly revealed.

While some would argue that Netflix’s agreement with Wal-mart was just another example of their business acumen, nearly four years after this transaction took place, Walmart and Netflix both stand accused of engaging in anti-trust behavior over the deal. While Netflix does see its fair share of bogus lawsuits, after reading through the complaint, I think that this case may end up having more teeth to it than most of the frivolous lawsuits that are filed. (Warning: I’m not an attorney and this is merely my opinion.)

Because the overall DVD market is so much bigger than the online component that Netflix pwns/operates in, I think they’ll end up getting past this, but the complaint which was filed by Andrea Resnick, does do a good job of framing the debate and raises some prickly questions for Netflix/Walmart. Had Resnick tried to seek an injunction blocking the transaction back in 2005, most courts would have brushed aside any anti-trust arguments in a heartbeat, but by shifting the focus of their complaint beyond Netflix’s control over the DVD by mail category to Wal-Mart’s domination of the DVD sell through space, Resnick does a decent job of making his case.

According to the complaint,

Prior to and at the time of the agreement, Netflix and Walmart.com were actual competitors in the Online DVD Rental Market. In addition, Netflix, on the one hand, and Wal-Mart Stores and Walmart.com were actual participants and Netflix was a potential participant, with the means and economic incentive to sell new DVDs–in the absence of the Market Division Agreement. Defendants shared a conscious commitment to a common scheme designed to achieve the unlawful objective of dividing the markets for online DVD rentals and new DVD sales. The Market Division Agreement allocated the Online DVD Rental Market to Netflix, with Wal-Mart Stores and Walmart.com agreeing not to compete in that Relevant Market. The agreement also allocated new DVD sales to Wal-Mart stores and Walmart.com, with Netflix agreeing to refrain from selling new DVDs in competition with them. In addition to explicitly or de facto agreeing not to sell new DVDs, Netflix also obtained the Market Division Agreement by providing potentially valuable promotion to Wal-Mart Stores and Walmart.com.

(Note: bolded text provided by me)

I don’t know whether or not there was specific language in the agreement preventing Netflix from selling new DVDs to their customers, but I am looking forward to finding out more details during the discovery phase of the trial.

Feel free to read through the complaint yourself, but when push comes to shove, it’s hard for me to believe that the courts will side with Resnick on this one. For one, as Techdirt aptly points out, Netflix doesn’t have a monopoly on the market, they just have the fortunate luck of competing with a neutered Blockbuster for that space. I also would argue that Netflix or Walmart for that matter, doesn’t have the ability to corner the home entertainment market as alleged. If Resnick is successful in arguing that the DVD by mail industry is a unique market they may end up having some luck, but the reality is that the home entertainment market is a helluva lot bigger than DVD rentals via the internet. If the FTC didn’t have problems with Sirius and XM combining to create a single satellite radio company, it’s hard to accept the argument that Netflix’s actions prevented competition on an anti-trust scale.

Since 2005, we’ve seen a radical transformation occur in the VOD and video over the internet markets. During that time, we’ve also seen Redbox install over 10,000 DVD kiosk locations throughout the US, including a large percentage of those in Walmart locations. When you consider that last year, Blockbuster had more than four times as much revenue than Netflix, it begins to illustrate how small Netflix’s slice of the movie rental industry really is.

Only time will tell how far this one will go, but I think it’s worth keeping an eye on. While I’m confident that neither Netflix nor Walmart did anything wrong, the suit isn’t as black and white as I would like. If Netflix does end up having to make compromises as a result of their success, it could have a serious impact on their ability to transition to digital delivery without any turbulence.

Davis Freeberg is a technology enthusiast living in the Bay Area. He enjoys writing about movies, music, and the impact that digital technology is having on traditional media. Read more at Davis Freeberg’s Digital Connection. Davis is a Netflix shareholder.