This is not the mass merchant's first foray into the digital space. In 2008 it launched an online movie and TV download offer through its online entertainment portal, Tescodigital.com, offering Sony and Warner titles on a digital retail basis. Attempting to leverage its position as the UK's second largest DVD retailer, Tesco launched its first digital video initiative, 'Virtual DVD', in late 2009, partnering with Microsoft to provide customers of select Warner DVD titles with a digital copy which included 'extras' material. The service struggled to gain traction, due in part to limited catalogue and the lack of a way of getting content off the PC, and was closed in 2010. Rather than start from scratch or partner with a third party, Tesco has opted this time to purchase.

Tesco has been clear about its intention to coordinate its 'Bricks-and-Mortar' stores and online offers, using the digital space to unlock and add value to the purchase of physical discs. In this context the acquisition of a majority stake in Blinkbox can be viewed for the most part as a platform buy. Although the Blinkbox service has never generated large transaction volumes, it offers Tesco a fully operational service with an already extended footprint on other third party devices.

The retailer is taking a long-term view, hoping to transition its DVD consumers online. In the short term this is likley to take the form of combining digital and physical product either with a new enhanced digital copy initiative or with in-store vouchers which can be redeemed for the digital version of the movie. Migrating loyal consumers of physical goods into loyal consumers of digital goods has proven difficult for retailers in part because they have not been able to offer the convenience and seemless user experience of the device-based ecosystems, like Apple's iTunes. It is no surprise then that Tesco is understood to be one of the UK retailers most proactively looking at Ultraviolet as a way to help its customers become digital consumers.

Longer term though this points to a bigger issue for Tesco. Supermarket giants have traditionally built their DVD sales volumes based on competitive pricing. This relatively low margin business helped to improve revenues across the wider business (and in many respects Apple has repeated the same approach to selling movies, capturing the value in hardware sales, not content). As a result of Apple's aggressive pricing and early market dominance consumers now expect prices in digital that can only be provided with low content margins for the retailer which means that, long term, it is only worth pursuing if Tesco can generate enough of a 'halo effect' from digital and use Blinkbox to drive revenues for other products and services. While this effect is well documented for the devices that surround the iTunes store, there has yet to be a clear success story from a more traditional retailer: even Walmart, whose Vudu service saw strong gains based on living room hardware penetration and competitive pricing towards the end of 2010, has yet to feed that success back into the company's core retail offer.

From a studio perspective there is another worry here. For all Tesco's interest in developing a digital retail proposition, this strategy of using movies to improve the value of the total portfolio of services it offers could be as well served if the company were to develop a compelling rental proposition. Consumers in the UK are increasingly demonstrating a preference for digital rental, a trend seen in the US and across key European territories in 2010. If this trend continues then it may well be that the supermarket can effectively create the same benefits while eschewing digital retail (with its high wholesale price and correspondingly low margins for the retailer) in favour of lower cost, lower trade price, rental product.