'If you told me you'd make a good profit at a competitive price and a better one at a higher price, OK. But when competitive pricing would knock out your total profit margin, that's troubling.'

Bill Lanphear

We sent the Video's 1st case study to a variety of industry observers, moneymen, and potential competitors. Here is some of what they told us:

IRA MAYER AND PAUL SWEETING

Analysts; editors of Video Marketing Newsletter, published in Los Angeles

When people ask us about going into video retail, we tell them, I'm afraid, that the time is past. The industry has peaked. There is already a lot of shake-out. Video-rental income will be essentially flat for the next two or three years, and the number of retail video stores has stabilized. There is less and less of an aftermarket for used tapes, which Video's 1st is counting on being able to sell.

Obviously, Video's 1st thinks differently, but if we were advising investors, we'd say no way -- steer real clear. The time is over for this sort of thing.

The idea that customers aren't sensitive to price -- that they care more about convenience and about getting exactly the tape they want -- has always been a nice theory, but history doesn't substantiate it. The pricing of rentals responds to local competition. And it's a cutthroat market. One dollar is not uncommon, compared with Video's 1st's $2.95. It sounds nice that people would pay a premium for convenience or mystique, but people have tried it, and it hasn't worked.

They should give up on the idea of being national. Try to grow market by market instead. Go into a market that isn't oversaturated with existing video retailers and blanket it with kiosks, then concentrate advertising and promotional efforts in that market. Get the most bang for the buck. Don't spread yourself too thin for the sake of national ambition.

Look, it's not just that the concept is flaws. It's also the fact that the market isn't ripe anymore -- it's mature. We think the window has closed for video retailing.

TROY COOPER

Competitor; executive vice-president of National Video Inc., a Portland, Ore.-based chain of 580 franchised video stores

I think the concept has some validity, but implementation is going to be much more difficult than they think. They haven't discovered something by magic that no one else has seen. it's a strategy we've thought hard about. But there are problems.

One is that they really underestimated their reinvestment in videocassettes each month. They expect to do 116 rentals per day, or 3,480 per month. On a minimum inventory of 300 cassettes, which is what the pro forma assumes, that's an average of 11 1/2 rentals per cassette per month. Now this turn rate is possible. In our experience, the turn on new releases can be pretty high for the first 30 days -- maybe as high as 20 rentals for a particular cassette. But it drops dramatically, to about 8 rentals, over the next 30 days, as the title loses its gleam. And in the third month the turn falls to the norm of 2 or 3 rentals per cassette per month.

Therefore, to average 10 or 11 turns a month over the life of a title, you can't keep it more than 90 days. After that the average drops, and Video's 1st wouldn't meet its revenue needs. So, they have to renew their entire inventory every three months (actually, they'd have to keep inventory fresh by bringing in a third of the total, 100 new tapes, each month while dumping the 100 oldest ones). The problem is those 100 tapes would cost -- studios are increasing their prices, not decreasing them -- anywhere from $65 to $70 wholesale. That means they would have to reinvest $6,500 to $7,000 a month to keep their inventory fresh -- more than twice what they've figured. In fact, it puts them in a negative cash flow. If they really do buy 55 tapes a month, as they say, then they'll have to keep each one for almost six months before the 300-tape inventory is renewed, and that won't work. They wouldn't be carrying the hits, as they claim.

The second problem is that video traffic comes in bunches: 70% of your business takes place on Friday, Saturday, and Sunday, and even that 70% is generally crammed into a few peak hours during each of this days. Now, if you have long lines of cars during these peak periods, you're going to discourage people from even lining up. When I go to a McDonald's, for instance, and see six or seven cars in front of me, I just keep going. And I think that's what's going to happen. In a regular store, you might combat the traffic from that peak rush by opening three or four terminals. Also, inside a store customers can browse until they see the line lessen a little -- there are things for them to do. And they don't see the line until they get into the store in the first place. The difference in Video's 1st's case is that their customers are going to see the line before they ever turn into the parking lot.

Those are the two biggest weaknesses of the concept: the first means that expenses will be much greater than what they're anticipating, and the second means revenues may be less than what they're anticipating because they can't generate enough rentals during Video's 1st's peak periods.

Will they make it? My gut feeling is no.

But I'll certainly watch them, and watch with interest. And if they do make it, then the threat is exactly what they mentioned in the beginning: anybody can reproduce it. I don't think 12 to 18 months lead time is anything. There will be lots of other people jumping in with the same concept.

BILL LANPHEAR

Financier; partner in The Early Stages Co., a San Francisco venture capital firm specializing in consumer products and retailing

Would this work as a prospective venture capital investment? Absolutely not. There are two reasons: the inexperience of the founders in their field, and the unlikelihood of building value for shareholders. These are low-volume outlets. It takes more than 7 of them to make a million dollars of sales for the system -- nearly 400 of these to make $50 million. That starts to get into lots of problems in terms of controlling that big a network. And of course, even those numbers won't yield much to the franchisor, who gets only a small cut of the system's take.

Also, look at their pricing: it's high end. Their projections show that they can totally wipe out profitability if the retail price drops by a third. They're supposing that convenience and multiple copies of the current movies will cause people to shop there instead of getting the movie through some more difficult process at a lower price -- a risky supposition. They could fall to break-even by a drop in volume or by not being able to maintain their price level, or any combination of those things. Whatever the average price now is -- say $2 or $1.99 -- it isn't stable. It might drop by a dollar. They probably now have, and will continue to have, competitors who are not primarily in the business of renting tapes, and who'll undercut. I'm worried about a concept that depends for all its profitability on a pricing differential. If you said to me that it makes a good profit at a competitive price and a better one at a higher price, so that if they had to be competitive it wouldn't put them out of business, OK. But when it knocks out the total profit margin, that's troubling.

Here's what I'd recommend to them:

1) Invest in providing excellent franchise operating benefits -- tape resale programs, buying programs, signage, marketing tools, kiosk design -- so these stores rise above others in the market and we implement better.

2) Don't defer your own rewards too long; maybe you can make a nice living for a while. Think in terms of getting your rewards in the next two years because the business may not be something you can sell for millions of dollars down the road.

Will you find them in the telephone directory two years from now? I'd say there's a reasonable chance of that. My crystal ball says they'll be around for two and a half years, then I get nervous.

ARTHUR GRUEN

Consultant; cofounder of Wilkofsky Gruen Associates Inc., a New York City firm specializing in the entertainment industry

In a very competitive market, they're proposing to carve out a nice little niche for themselves. I think their prices are fine, because people will pay a reasonable premium for convenience. Their concept makes perfect sense, at least for them as franchisor.

What's not clear, however, is what they're going to do for potential franchisees that an individual entrepreneur, acting on his own, couldn't do for himself. Anyone can put up a kiosk and stock it with tapes, just like anyone can cook a hamburger. But having the McDonald's name on your hamburger stand makes it a more valuable asset. What does Associated Video Hut propose to do to add value to the Video's 1st name -- which is the main thing they can do for franchisees? If they don't build an identification in the public's mind between product and logo, then they've go nothing to sell.

BARRY ROSENBLATT

Competitor; president and CEO of Video Library Inc., a chain of 42 company-owned video stores, all in San Diego

I think that in order to do the revenue they need, the lines will be too long. We do 15% of weekly rentals in four hours on Saturday afternoon. Using their numbers,they'd be handling during that peak period about 30 to 35 customers per hour. Can you take care of that much business, through a window, without creating massive lines that will turn your customer off? When I think of how long it will take to do a transaction, and when I think about how customers would have to line up to return the movies, too, I just can't see it. No one can take care of people that fast.

And there sure are reasons to grow from one area into another instead of going national immediately: you've got to handle these things, you've got to take care of them. Franchisees need to be serviced very, very well, or they won't survive -- or, even if they do, they'll stop paying you royalties, because they'll think you don't deserve them.