When a small shop opened in Texas 20 years ago renting out a newfangled technology called video cassettes, its owners knew they were on to a winner. By the end of the next year, Blockbuster had 19 stores in the US. Within a decade it had become the world's biggest video rental chain, satisfying a seemingly unquenchable thirst for viewing films at home from London to Sydney.

That progress came to a shuddering halt yesterday when the company said it had suffered a £32m loss over the past three months. The US-based retailer saw its global revenues drop by 2 per cent to $1.4bn (£780m). Last year, it made a profit of £27m in the same period.

The company, which has 700 stores in Britain, claimed the dramatic reversal in its fortunes was due to a succession of Hollywood flops reducing the numbers going to the high street to rent a film and an onslaught from internet-based competitors.

The retailer thrived throughout the Nineties, boosting its presence throughout North America, Europe, Asia and Australia to 9,100 stores by meeting demand for videos, now themselves facing extinction - 111 million films were sold on DVD last year, compared to 13 million on VHS.

Blockbuster, which is likely to stop stocking VHS cassettes at the end of the year, said it was also facing competition from online DVD rental companies that send discs by post, as well as the losses to piracy and mass retailers.

The conglomerate has set up its own internet service to meet head on new competitors such as Lovefilm.com and Tesco, which boasts a library of 15,000 titles and charges £14 a month for a rotating selection of up to three films. Blockbuster insisted that despite its losses, overall rentals had increased and its online business, which charges £15 a month for unlimited DVD rentals, was thriving with one million subscribers worldwide, a figure it expects to double by next year. The monthly fee normally includes a pre-paid envelope to return each disc.

Blockbuster said the turmoil in the rental industry meant it could no longer forecast its income for 2005 and predicted a further drop in revenue in the next three months. It said: "Blockbuster believes that the continuation of overall industry weakness will adversely impact the company's performance during the third quarter of 2005." Since the advent of DVDs in the late Nineties, the global rental market has shrunk dramatically as Hollywood studios seek to increase income by concentrating on the mass retail of DVDs.

Studios, which gain a greater proportion of the selling price from DVDs sold by retailers such as HMV or Amazon than through rental stores, have sought to reduce the price difference between renting and buying a disc to make outright ownership of a film worthwhile. As a result, the proportion of the money made by Hollywood from film rentals has dropped from 15 per cent in 1997 to a current level of less than 5 per cent.

Some experts have said the days of the rental market as a whole are numbered as broadcasters step up preparations to offer programmes direct through the internet. BSkyB has unveiled plans to allow customers to download films and sports over the internet later this year. The cable companies NTL and Telewest are expected to follow suit shortly while BT is working on a broadcast download service. One company, HomeChoice, already offersvideo-on-demand in London.

Helen Davis Jayalath, the senior media analyst for the consultancy Screen Digest, said: "Companies like Blockbuster are diversifying but they will never be able to beat the convenience of pressing a button on your television set. The only question is whether the video-on-demand services will be able to offer the breadth of product that the online DVD companies offer."

The DVD battleground

ALEXANDER

BLOCKBUSTER, Ballards Lane, Finchley, North London

Available (£3.95 for two nights)

TESCODVDRENTAL.COM (One DVD at a time £7.97 per month, three DVDs £13.97)

Available

LOVEFILM.COM (One dvd at a time £9.99 per month, three DVDs £14.99)

Available

BLOCKBUSTER.CO.UK (Five night rental new release £4.50, three DVDs at a time £14.99 per month)

Available

MAGIC ROUNDABOUT

BLOCKBUSTER, Ballards Lane, Finchley, North London

Available (£3.95 for two nights)

TESCODVDRENTAL.COM (One DVD at a time £7.97 per month, three DVDs £13.97)

Available

LOVEFILM.COM (One dvd at a time £9.99 per month, three DVDs £14.99)

Available

BLOCKBUSTER.CO.UK (Five night rental new release £4.50, three DVDs at a time £14.99 per month)

Available

MOTORCYCLE DIARIES

BLOCKBUSTER, Ballards Lane, Finchley, North London

Out on rent

TESCODVDRENTAL.COM (One DVD at a time £7.97 per month, three DVDs £13.97)

Available

LOVEFILM.COM (One dvd at a time £9.99 per month, three DVDs £14.99)

Available

BLOCKBUSTER.CO.UK (Five night rental new release £4.50, three DVDs at a time £14.99 per month)

Available

BATTLESHIP POTEMKIN

BLOCKBUSTER, Ballards Lane, Finchley, North London

Not Stocked

TESCODVDRENTAL.COM (One DVD at a time £7.97 per month, three DVDs £13.97)

Available

LOVEFILM.COM (One dvd at a time £9.99 per month, three DVDs £14.99)

Available

BLOCKBUSTER.CO.UK (Five night rental new release £4.50, three DVDs at a time £14.99 per month)

Available

THE THIRD MAN

BLOCKBUSTER, Ballards Lane, Finchley, North London

Not Stocked

TESCODVDRENTAL.COM (One DVD at a time £7.97 per month, three DVDs £13.97)

Available

LOVEFILM.COM (One dvd at a time £9.99 per month, three DVDs £14.99)

Available

BLOCKBUSTER.CO.UK (Five night rental new release £4.50, three DVDs at a time £14.99 per month)

Available