Time Warner (NYSE: TWX) is not thrilled with the transition from the sale of physical media to digital distribution. Why can’t people just keep buying millions of DVDs like they did ten years ago? DVD and Blu-ray disc movie sales declined a whopping 13% in 2009, cutting deep into movie studios’ profits. Company’s like Sony, who recorded record profits from theatrical releases during the same period were forced to layoff 450 employees due to the shrinking market for physical media. While piracy is certainly a factor in the disappearance of DVD audiences, the increase in viewers of on-demand and streaming video over set top boxes from cable providers like Comcast (NASDAQ: CMSCA) and services like Netflix (NASDAQ: NFLX).

Earlier this year, Time Warner introduced a plan to delay the release of Warner Bros. films to streaming services and other rental outlets. CEO Jeff Bewkes announced at the beginning of August that the initiative to delay the rental of movies newly released on DVD for 28 days had greatly boosted sales of the studio’s films Sherlock Holmes and Harry Potter and the Half-Blood Prince. Time Warner understands that this strategy won’t preserve their physical disc sales forever; the company unveiled plans to roll out an on demand service for new movies to begin next year. Time Warner CFO John Martin told investors during a conference call with Goldman Sachs that Warner Bros. films will be released on-demand through a premium service that would charge audiences $20 to $30 to watch a film after its theatrical run but before it’s available on DVD or streaming outlets like Netflix. While Martin didn’t outline how exactly Warner Bros. would time these releases so as not cannibalize theater ticket sales, an unnamed industry insider said that the studio is going to gingerly stagger releases on a case by case basis when it launches the service next year.

Despite the outward confidence expressed to investors, Time Warner’s delayed rentals plan and the new proposed premium on demand service both betray a troubling lack of understanding of the video entertainment market. While movie studios like Lions Gate Entertainment (NYSE: LGF) are moving quickly to offer their content through streaming services like the new Google Inc. (NASDAQ: GOOG) Google TV and YouTube Films outlets, Time Warner is desperately clinging to old revenue streams that will not survive the next decade of growth in entertainment technology. While there are numerous factors that have contributed to the 54% decline in TWX share price over the past four years, it’s hard to ignore the fact that TWX stock was trading at $68.19 at the beginning of 2007, during the height of the DVD market, and at $31.51 today. Premium on demand and rental delays aside, Time Warner needs to follow Netflix’s lead on how to reach not just the home audience of tomorrow but the audience of today.

Even Netflix, whose share price is north of $165 today, up +72% year-on-year, is giving up on physical media. While the company began its reign of the American movie rental business by mailing DVDs, they are increasingly shifting to a purely on demand streaming over the Internet distribution model. Netflix currently offers streaming services through Web browsers, apps on Apple Inc.’s (NASDAQ: APPL) mobile devices like the iPhone, and video game consoles like the Microsoft (NASDAQ: MSFT) Xbox 360, Sony (NYSE: SNE) Playstation 3, and Nintendo (PINK: NTDOY) Wii. This week, the company announced that they are going to be expanding into Canada but will forego disc rentals entirely. Canadian Netlix subscribers will have access to streaming content only, for a membership fee of $7.99 per month, half the cost of a membership that includes disc rentals in the United States. Time Warner should take note; audiences are more than happy to be recurring low fees for unlimited access to content. They are not going to pay $30 to watch a movie they can just as easily pirate for free.

Time Warner shareholders and investors should be very concerned about these new strategies.

As of this writing, Anthony Agnello did not own a position in any of the stocks named here.

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