The Media Wonk

Back when the VCR first appeared, along with the video-rental market it spawned, it offered consumers something they had never had before in their home entertainment experience: do-it-yourself programmability. Renting a movie from the video store bought you not just two hours of entertainment. It bought you any two hours of entertainment–on your own schedule, continuous or not, experienced once or repeatedly–anywhere you had a VCR, which fairly quickly became anywhere you had a TV. In exchange for that flexibility, consumers were willing to suffer the inconvenience of a return trip to the video store.

The studios flattered themselves by insisting their content was “king,” and that their movies provided most of the value for renters. But the evidence says otherwise. For a decade and a half, consumers routinely put up with having to rent something other than their first choice of title because the basic value proposition of renting–any two hours of entertainment–was greater than the value of any particular title.

When DVDs came along, they offered everything that VHS offered consumers while enabling new usage cases and capabilities. The cost characteristics of pressed discs made movies ownable (rather than just rentable), eliminating the need for a return trip to the video store, while the small form factor made them easily portable. The introduction of DVD drives in PCs and laptops greatly expanded viewing options. Even the fact that DVDs could easily (if illegally) be copied, much as it pained the studios, added to the functionality of the format for (some) consumers by making the content portable without the disc. The net result was a quantum leap in consumer spending on home video, even though movies themselves, as measured by box-office grosses, were no more valuable than before.

Imagine, however, if DVDs had not added more and new functionality to the home video experience but less. Imagine if DVDs could only be played at certain times, for instance, or on certain TVs, or that players had to be connected to the Internet to work. If switching to DVDs had meant consumers could do less with the movies they bought and rented than they could with VHS, even given DVD’s superior picture and sound, how many people do you think would have made the switch? Some, surely, but I’d bet you could still by a VCR at Best Buy today if that had been the case, and I’d bet total consumer spending on home video would still be where it was in 1998, not 2008.

The value that was added to the home video market since the introduction of the DVD, as reflected in the increase in consumer spending, was a result of the increased functionality and superior quality of the format versus VHS, not to any qualitative improvement in movies. It would be folly, therefore, to expect that whatever comes after DVD (and I don’t mean Blu-ray) could offer consumers less than DVD does in terms of functionality and quality and still achieve comparable levels of consumer adoption and spending, let alone increased levels.

Anyone who doesn’t believe that need only take a look at the doleful report released this week by ScreenDigest on the movie download market. According to the researchers, paid movie downloads and VOD amounted to a mere $291 million last year, well below ScreenDigest’s previous forecast of $360 million in revenue for 2009. The analysts blame the shortfall, correctly in my view, on the limited functionality provided by most download services.

“Digital downloading is characterised by its restrictions – it’s all about what viewers can’t do, rather than what they can do,” ScreenDigest research director Arash Amel told the Financial Times.

It should be clear from the history of the home entertainment market that consumer expectations with respect to convenience, functionality, portability and interoperability are accretive and cumulative. They move in one direction only.

Whether the studios like it or not, to consumers, “home video” today means, “what I can do with a DVD.” That’s the irreducible benchmark against which any new delivery modality will be measured. If it doesn’t measure up to the functionality of DVD, it’s not going to be acceptable. The studios cannot go backwards and expect the consumer to follow.

Let’s stipulate that the $100 million price tag being bandied about for Walmart’s acquisition of Vudu is exaggerated, or includes various earn-out targets that likely will never be met, making the ultimate price something less than nine figures. Walmart hinted at as much in its press release, indicating the acquisition would “not be material” to its first fiscal quarter despite being scheduled to close within that period, suggesting there are triggers and contingencies in the deal that will play out over time, if at all.

Yet the fact that we’re even talking about a price that could reach into the $100 million ballpark suggests there’s something more going on here than meets the eye.

Or maybe not. Perhaps, as has been suggested, Vudu,  somehow, simply blew smoke up Walmart’s ass and convinced it to overpay for a marginal VOD provider. Or perhaps, as Streaming Media’s Dan Rayburn argues, Walmart simply doesn’t know what it’s doing in digital delivery and is setting itself up for another massive VOD fail.

But I think that’s too narrow a view of what Walmart is up to.

From Walmart’s perspective, Vudu has a number of valuable assets that make it more than simply a VOD provider with some nice content licensing deals. One of those is the HDX encoding format, which Vudu introduced back in 2008. With HDX, Vudu claims, it can deliver genuine 1080p video over the Internet in 4.5 Mbs of bandwidth. The format is optimized for LCD and plasma screens over 40-inches in size and incorporates a process Vudu calls TruFilm, which simulates the cinematic experience in a home theater by preserving film grain and other textural qualities of film.

That gives Vudu a distinct quality advantage over other would-be over-the-top video distributors, including Netflix, iTunes, Amazon and Xbox Live. Even the “high-def” content those services deliver is encoded in 720p at best, and at lower bit rates than Vudu uses. It also looks worse as screen sizes increase.

At some point, as consumers come to expect to watch Internet-delivered video on their TVs, they will begin to realize how crummy most IP video looks on their 50-inch LCD display, even compared to noisy, over-compressed cable HD.

That day is coming faster than you might think, too. According to a survey conducted by iSupply, 25% of all TV sets sold in America in January were connected to the Internet by the middle of February, either directly or through a game console, Blu-ray player or other set-top box.

More significant for Walmart, though, is that HDX and TruFilm are proprietary. Vudu does not–or at least need not–interoperate with other streaming or download services built to support other encoding formats, or with content encoded in those other formats. It’s a closed channel, like iTunes, only with a decent-looking picture.

That’s where Vudu’s other asset to Walmart comes in: It has deals in place to embed its streaming platform in HDTV sets and Blu-ray players with seven of the nine largest TV makers by market share.

Now imagine you’re one of those TV manufacturers. Walmart sells about 15% of the HDTV sets nationally, but for some manufacturers, like Vizio, it’s market share is far higher. Not only do you have a powerful incentive to embed the Vudu platform in devices you hope to sell through Walmart, you have an incentive to not embed anyone else’s, for fear your products would be marginalized on the Walmart sales floor, assuming they even got that far.

If your not one of those manufacturers licensed by Vudu you have a strong incentive to become one if you have any expectation of selling your products in Walmart.

Over time, then, if all goes well, Walmart will accrue a very large installed base of connected TV sets and set-tops with its proprietary streaming platform baked in–much larger than anyone else’s installed base.

Other retailers will be significantly disadvantaged, forced to choose between selling devices with Walmart’s software embedded, or selling brands that cannot access content from the most popular service. Other service provides could also find life far more difficult as well.

Now imagine you’re a movie studio or other content owner. The DVD business is collapsing around your ears. What’s left of it is going to subscriptions and dollar-a-night rentals, leaving you sucking hind tit, margin-wise. Blu-ray will keep the packaged media sell-through business alive for a while, thanks to retailers like Walmart and a few others, but that’s not exactly a growth strategy.

Eventually, if not already, you will need a transactional, on-demand rental (and perhaps sell-through) channel that delivers real HD video to the living room. And you have to develop that business without disrupting the Blu-ray business before it’s time.

Now think about how much you could end up needing Walmart: It’s the largest buyer of Blu-ray discs in the world, keeping your packaged media business alive, and it could soon have the largest, proprietary channel into the living room for IP-delivered video.

That’s going to leave a mark.

The strategy isn’t perfect, of course. Consumers are yet to warm to VOD, despite a decade of effort by the cable industry and later by the likes of CinemaNow, Movielink, iTunes and others. It also doesn’t solve the problem of content portability between devices. But imagine (it’s not much of a stretch) that Walmart were able to use its leverage with the studios to carve out for itself an exclusive, high-def VOD window via Vudu immediately after a movie’s theatrical run and ahead of its release on Blu-ray. What might that do for consumer adoption of VOD?

Vudu’s business right now is VOD. But that doesn’t make its acquisition a VOD deal from Walmart’s perspective. While it’s not a sure thing, the Vudu acquisition gives Walmart tools it can use to try to establish and control the de facto industry technical standard and the dominant distribution platform for delivering high-def video to the living room via the Internet. If successful, it would be in a position to extract rents (in one form or another) both from content owners and device makers for use of the standard and platform while leaving other retailers and service providers at a distinct disadvantage.

That might well be worth $100 million some day.

Having failed to put forth a competitive consumer proposition to counter Redbox’s dollar-a-night DVD rentals, the studios are on the verge of accomplishing what, from the point of view of their own economic interests, is the next best thing: they have brought the rental kiosk operator to heel and effectively forced it to accept a 28-day window after street date before it begins loading their DVD releases into its ever-expanding red maw.

On Tuesday, Redbox and Warner Bros. announced an agreement to settle the litigation the kiosk company had brought against the studio last year. As part of the deal, Redbox agreed to a 28-day “vending” window and to limit sales of used Warner discs. In return, Warner will allow Redbox to acquire its releases at a lower cost and promised to “cooperate” with Redbox on possible future digital delivery ventures.

While Tuesday’s settlement applies only to Warner, it’s widely expected that similar deals are in the works with Twentieth Century-Fox and NBC Universal, which are involved in similar litigation with the Redbox. Assuming that happens, new releases will essentially disappear from Redbox kiosks.

Make no mistake. Redbox rentals were hurting DVD sales and undercutting the studios’ other revenue streams. Its dollar-a-night rentals accounted for roughly one of every five dollars consumers spent on DVDs last year, and it returned a far smaller share of that dollar to the studios than Wal-Mart sends them when it sells a DVD. And from the studios’ perspective, the trend lines were getting worse. Something had to be done. Read more…

Speaking of windows, Disney has touched off quite the firestorm in Europe over its plan to release “Alice in Wonderland” on Blu-ray and DVD just 12 weeks after its March 5 worldwide theatrical debut instead of the usual 16 to17 weeks. Holland’s National Board of Cinema Owners is up in arms, and has organized a boycott among that country’s four largest theater chains, representing some 80-85% of screens. Three top chains in the U.K. are threatening to follow suit, vowing to keep Tim Burton’s 3D extravaganza off 95% of the 3D screens in the realm unless Disney backs down.

Good luck with that. I don’t see Disney backing down on this one. It obviously picked this fight with theater owners now because it knows it has the leverage to win. “Alice in Wonderland” will be one of the biggest-grossing theatrical releases of the year, with or without wide distribution in The Netherlands, and it has “Toy Story 3″ in the wings, which will be even bigger. In crude terms, the theaters currently threatening boycotts need Disney’s movies more than Disney needs their screens, and both sides know it (U.S. theater operators have more leverage, of course, which is why Disney apparently has cut some sort of deal with NATO that would let it “experiment” with windows on one or two movies a year so long as it doesn’t make a habit of it).

The real question is: why is Disney so intent on getting “Alice in Wonderland” out on DVD and Blu-ray so soon.

In an interview with CNBC last week, Disney CEO Bob Iger said the early “Alice” release would allow the studio to “put the video out before the doldrums of the summer and to put it out when the movie is very fresh in consumers’ minds.” Read more…

Book publishers have been crowing this week over having wrested control over e-book prices from Amazon. After a brief showdown with Macmillan Publishing, in which Amazon pulled all Macmillan hardcover and paperback titles from its physical-book store, the Kindle maker blinked and agreed to the publisher’s demand to raise the price of its e-books in the Kindle store from $9.99 each to $12.99-$14.99. Other leading publishers, led by Hachette Book Group and News Corp.’s HarperCollins unit, quickly said they would demand the same deal.

The publishers, of course, have long been concerned over Amazon’s strategy of pricing most new release e-books at $9.99 to spur sales of Kindle devices. Though publishers earn the same $12-$14 wholesale price from Kindle editions as they earn from hardcovers, they fretted that low prices on e-books would undercut sales of hardcovers, which typically sell for $20-$25 at retail. Eventually, they feared, the reduction in retail revenue would result in lower wholesale revenue as well. So long as Kindle owners made up the largest slice of the e-book market, however, the publishers had little choice but to go along. Read more…

The memo Sony Pictures co-chiefs Michael Lynton and Amy Pascal sent to employees Monday announcing massive layoffs, most of which will fall in the home entertainment and IT divisions, obviously wasn’t meant to be made public. But it’s fitting that it was leaked when it was, the same day that Bernstein Research analysts Michael Nathanson and Peter Choi published what amounted to an obituary for packaged media as a profit driver for Hollywood.

According to Bernstein:

For 2009-2012, we [previously] forecast overall U.S. home entertainment industry revenues to decline at a -2.1% CAGR. This underscores the mature nature of the industry, plus the importance of share gains for individual players. Over this time frame, aggregate operating profit declines of low single digits are also expected.

Now one year later, looking at the cold hard facts of 2009, retail spending on sell-through DVDs and Blu-Ray discs dropped by -18% while rental of these products actually increased by 4%. As a result, the sell-through of physical discs declined from 63% of the market to 57%.

This massive change in behavior continues to have negative implications for studio profitability as every home video executive would rather book the $16 of profit contribution per transaction from selling a disc vs. the $3.50 to $1.40 per disc profit contribution from rental.

[snip]

Our analysis also shows that the Blu-Ray format is having a more modest acceptance rate that traditional DVD. In 2009, three years after its introduction, Blu-Ray’s penetration of TV households stood at 4.4%, compared to 13.0% for DVDs in 2000. We also find that Blu-Ray [sic] has seen lower numbers of titles shipped per converted household relative to DVD. We don’t see Blu-Ray stemming the decline of physical sales. Read more…

It’s here. After nearly a year of carefully orchestrated speculation and hype, Apple has finally unveiled: the “iPad,” thus causing millions of women across the blogosphere, in unison, to go, “eewwww.”  (Are there no women in the marketing department at Apple?)

Among the less lunationally sensitive, the verdict has been more mixed, but the rough consensus seems to be that, at this point at least, the iPad is basically an iPod Touch on growth hormones: neat, but not quite overwhelmingly amazing, fantastical and way-cool the way the iPhone seemed when it launched.

Particularly disappointing to some, or at least puzzling, was the relative scarcity of media apps at launch for a device that was billed as revolutionizing the media industry, leading many to wonder what you’re supposed to do with the thing.

I have no doubt those apps will come, however, not only because Apple has already released an iPad SDK but because of what it offers media companies. Read more…

More from the be careful what you wish for files: As The Media Wonk noted in a previous post, there is more to France’s three-strikes law than just three-strikes. One less-discussed provision is the strict regulation of movie release windows by the government, taking a key strategic decision out of the hands of the studios. One early victim of that provision appears to be Twentieth Century-Fox, which has scheduled the release of Avatar on Blu-ray and DVD in France for June 1–several months earlier than ordinary business considerations would dictate but necessary to comply with the law.

That provision isn’t the only booby-trap in the law for content owners, however.

The Creation and Internet law, after all, which went into effect on Jan. 1, wasn’t passed only to crack down on digital piracy. It was also intended to promote the legal availability of “multimedia” content on digital platforms. As it turned out, content owners probably should have paid more attention to that end of the deal.

In the spirit of promoting availability, France’s Minister of Culture, Frédéric Mitterrand, ordered up a commission to study and make recommendations on ways to facilitate availability. To head the commission, Mitterrand named Patrick Zelnik, CEO of Naive Records, which happens to be the label for which French First Lady and pop chanteuse Carla Bruni-Sarkozy records (that’s just the way they do things in France).

The Mission Zelnik, as the commission came to be known, issued its recommendations in early January, and they included a number of surprises. Topping the list was a proposal to implement a collective rights licensing scheme for music on digital linear platforms (i.e. webcasts), in effect a compulsory license. The commission also recommended a “voluntary” collective licensing scheme for non-linear platforms (downloads and on-demand streaming), with the stipulation that if the industry can’t come up with a satisfactory “voluntary” scheme within a year the government should mandate one. Read more…