January 3, 2005, 12:00 AM

Who wins if Amazon offers online DVD rentals?

Watch out, Netflix, Amazon is offering DVD rentals in the U.K. and hints that the U.S. market is not far behind.

If Amazon.com Inc. decides to enter the American online DVD and video rental market, Netflix Inc. may feel the impact more than Blockbuster Inc. At least that’s the way events unfold in a scenario described by Michael Pachter, analyst in the Los Angeles office of Wedbush Morgan Securities Inc. who follows the video rental market.

Amazon has begun renting DVDs and videos online in the United Kingdom and has hinted strongly that it may take on the market on this side of the Atlantic, too. “Amazon customers have been asking for the service, and we believe we’re well-positioned to offer a great customer experience,” an Amazon spokeswoman says. “Stay tuned.”

In a way, however, Amazon isn’t so well positioned to enter the American market, according to Pachter. It’s a problem of distance, sales tax and outsourcing.

Here’s why: Online retailers are under increasing pressure from state governments to collect state sales tax on web transactions if they operate any stores or distribution centers in the state. Observers say companies that rent DVDs and videos online need distribution centers near almost every major population center so that customers can receive movies by mail in a day or so.

If Amazon set up 30 distribution points, suddenly the people who buy everything from camera lenses to cars would find themselves paying sales tax. Amazon doesn’t want that, says Pachter.

Instead, Amazon probably would outsource distribution of the DVDs and videos. The third-party could operate the distribution points and Amazon itself wouldn’t have to establish a physical presence in multiple states and start charging state sales tax for everything on its site.

Who might Amazon tap for third-party distribution? Why not Blockbuster, suggests Pachter. Blockbuster probably wouldn’t mind helping out a competitor, because Amazon would probably be satisfied with 10% of the market, he says. Pachter also reasons that an Amazon partnership with Blockbuster would put pressure on Netflix and possibly eliminate a competitor, while an Amazon partnership with Netflix probably wouldn’t inflict much damage on Blockbuster.

Besides, even if Amazon weren’t entering the mix, Netflix will begin falling behind Blockbuster in online rentals in a couple of years, predicts Pachter. Netflix has signed up 2 million subscribers in five years, while Blockbuster appears likely to take on 500,000 in less than six months, he says.

Blockbuster undercuts Netflix on rental price and even throws in coupons to lure subscribers into the stores, Pachter says. Netfilx wins points for having the slicker web site interface, but Blockbuster still leads the scoring with its instant, widespread name recognition.

Pachter doesn’t even credit Netflix with forcing Blockbuster’s hand when the latter recently declared a policy of no late fees. Blockbuster was mimicking Hollywood Video, he says, which offers five-day rentals. Blockbuster late fees have been collected mainly on the third or fourth day the movie was out and amounted to only about 10% of rental income, Pachter says.

And what about Walmart.com, the other recent entrant into the online DVD rental market? Wal-Mart doesn’t project a stylish enough image to become a power in online DVD and video rentals, Pachter says. m

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