Circuit City Gambles on Digital Video

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Circuit City Stores

(CC) - Get Report

, the nation's largest consumer electronics retailer, is gambling more than $130 million on the launch of a new type of home video player. But although the company faces long odds in its attempt to upend the home video business, its chances are beginning to look better.

In its second recent attempt to expand beyond its traditional retailing business, the company announced last fall it had taken a majority stake in

Digital Video Express

, a partnership behind a videodisc format known as Divx.

Numerous participants in the home video business are rooting for Circuit City to fail. But the company got a major outside boost for Divx last week, and analysts say Circuit City has nothing more to lose -- and everything to gain -- as Divx comes to market.

Divx is a variant on DVD, the videodisc format featuring movies on CDs that came to market one year ago. Divx players, scheduled to debut in San Francisco and one other undisclosed city later this spring, will play DVD movies. They'll play Divx movies, too -- but there's a catch.

The way the Divx business is planned, you'll buy a Divx disc for a little more than the cost of renting it from a video store -- let's say about $4.50.

As soon as you stick the disc in your Divx player, a meter will start running. You'll be able to play the movie as often as you want over the next 48 hours, but afterward the machine will freeze you out. Then, you have two choices. You can throw the disc in the trash, or you can hold onto it in case you think you want to watch the movie again. Pay a little more money, and you can watch it again temporarily, or maybe for a higher price you can purchase unlimited viewing.

It may sound crazy to buy a movie that you can only watch for two days, but Circuit City thinks it can sell Americans on the idea. Consumers will enjoy the convenience of renting a video that doesn't have to be returned, says Divx spokesman Josh Dare. "Lots of times, that trip to take it back is five minutes to midnight," he says.

Home video buffs denounce the idea of Big Brother controlling how often they can watch a video. Video rental stores are unenthusiastic about a new format that might freeze them out. And consumer electronics retailers don't want to put money in their rival's pocket, when every unit they sell means more licensing money for Circuit City.

For example, Circuit City rival

Best Buy

(BBY) - Get Report

, which sells DVD players, is steering clear of Divx for now. Best Buy also happens to be on a financial upswing, recording a profit for the first nine months of its latest fiscal year instead of losses one year earlier. Circuit City's profits declined in the same period, and it reported lower same-store sales for the year.

But Circuit City has finally recruited another retailer to sell DVD. Starting in May, the 76-store western chain called

the good guys!

(GGUY)

will sell the Zenith-brand Divx player at 19 San Francisco-area stores.

"My focus is on my customers," says good guys! president Robert Gunst. "I would certainly prefer that somebody other than my competitor owns this technology. I'm not going to be petty enough to let that get in my way."

Though Divx is said to add $100 to the cost of a DVD player, Gunst says the Zenith model's $499 expected selling price is actually less than the average price he currently gets for selling current DVD players, which won't be able to play Divx discs at all when they're released. (

As originally posted, this story incorrectly listed the Zenith model's expected selling price as $399.

) "When it comes down to choosing a feature that may or may not be of value," he says, "why not purchase it if it doesn't cost you a lot?"

Steven Roorda, an analyst covering retail for

T. Rowe Price

, isn't sure whether Divx will take off, but he's interested in it. "Personally, I like the product," he says. "I have three teenagers who drive me crazy with tapes and returns. But I don't know how many others there are like me."

He says that the share price of Circuit City already reflects the money the company has spent on Divx, and can't suffer much more. "I think there's upside and very little downside," he says. Though same-store sales at Circuit City declined 1% from the year before in the company's fiscal year ended February 28, he says the outlook is good for both Circuit City and its money-losing auto retailing subsidiary,

CarMax

. (T. Rowe Price owned 2.7 million shares, or 2.7%, of Circuit City as of Dec. 31, according to data tracker

Technimetrics

.)

An institutional investor in Circuit City, who spoke on condition of anonymity, was cautiously optimistic about Divx's success relative to DVD: "If either of them works, it'll probably be Divx."

But numerous skeptics remain. No company other than the good guys! Has expressed any interest in selling Divx software, says Jeffrey Eves, president of the

Video Software Dealers Association

, a home video industry trade group. He says that video stores will make much less money from Divx than they can from DVD, and it will cost them too much to stock movies as tapes, DVD discs and Divx discs. "How many different ways do you need to watch a movie?" he asks.

Marjorie Costello, editor of the email newsletter

Consumer Electronics Online News

, agrees that Divx faces many hurdles if it wants a piece of the video rental business. "It may be too complicated for consumers," she says. "This is something that requires a little more work."