And there's no evidence yet that the internet is an alternative to the theatrical or video market, either as a sales or distribution medium.
There have been people who have made fairly significant money selling movies direct using Internet marketing. Maybe not a lot of people yet.
As to how do you compete with Hollywood? Well - you won't. Make a small movie for a niche and market it to that niche. That's a movie Hollywood will never make and can't compete with.
But people seem to think they are going to beat something like "Closer" which has 4 stars in a well written little drama. Yeah, forget it. Your little Romantic Comedy with no one in it won't see the light of day and I don't know how you'd go about selling it direct.