Format War Over, Home Video’s Future Uncertain

The implications of the HD DVD format demise go well beyond the role of distributing shrink-wrapped high-definition movies.
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Toshiba cleverly positioned its HD DVD hara-kiri as doing a favor for consumers.

“We concluded that a swift decision would be best,” Toshiba Corp. President Atsutoshi Nishida said, claiming that he wanted to avoid confusion among consumers.

Others might call it “saving face.” More pertinently, Toshiba’s departure from the next-generation DVD business stemmed from the company’s earlier decision to save money, or more precisely not to dole out enough financial enticements to studios and other partners. The company recently said it spent about $1 billion on its HD DVD adventure.

No matter what else may drive Japan’s keiretsu business alliances, it always comes down to money. And clearly Sony was willing to backup its Blu-ray Disc technology in ways that lured studios (notably the pre-CES Warner Bros. shift) and other partners to its side. The rapid-fire announcements from Blockbuster, Netflix and Wal-Mart in February that they would solely sell Blu-ray Discs were not simply technology decisions. To retailers, even more than to Hollywood, it’s all about revenue.

To Sony, Blu-ray’s survival meant “do or die” for its vital PlayStation business, which is built around that technical format. Hence, Sony had no qualms about spending whatever it took to assure that studios and retailers stuck with that format. Although Sony’s PS3 consoles now ranked third in the games world (behind Nintendo’s Wii and Microsoft’s Xbox 360), the future is all about videogames—which are now poised for an $18 billion revenue year, eclipsing the motion picture industry and starting to rival cable TV revenues.

SPOILS OF WAR

Sony is not the only maker of Blu-ray DVD players, but according to a DisplaySearch estimate in late 2007, Sony’s name was on 96 percent of Blu-ray devices worldwide—and most of those were PS3 boxes. The “format war” victory also makes it easier (i.e. salable) for Sony to install Blu-ray drives into the new Bravia TV sets and Vaio computers, creating more revenue potential.

From another financial perspective, Sony, Philips, Panasonic and Warner Bros. all own patents on Blu-ray technology. Their contributions to assuring survival of that format are seed money in their quest for new royalties from games and other applications. For Toshiba, the write-off of a few hundred million dollars spent on HD DVD is small yen against the company’s $60 billion annual revenue. Certainly Wall Street liked the decision, rewarding Toshiba with an immediate upwards bump.

The implications of the HD DVD format demise go well beyond the role of distributing shrink-wrapped high-definition movies. Yet the big question remains whether the elimination of a competitor assures that Blu-ray will enjoy unbridled growth—or if it will just face (on its own) the aggressive electronic delivery services now blossoming as high-speed cable and telco TV systems feed on-demand broadband HDTV programs to home viewers.

Among the backers of the HD DVD format were Intel, Hewlett-Packard and Microsoft, which uses it in its XBox 360 games consoles. A week after Toshiba’s withdrawal Microsoft said it will stop making HD DVD players, but it did not endorse Blu-Ray, saying only that “HD DVD is one of the several ways we offer a high-definition experience.”

Toshiba said it intends to maintain “collaborative relations” with its technology partners, using the assets generated during HD DVD development. But no one seems to know yet exactly what that means.

While the quick end to the format war soothed the nerves of unhappy electronics dealers, it may not jump-start the home video category. Traditional DVD sales and rentals have flatlined for more than a year, fueled by a combination of factors: too many lousy movies, distraction from VOD, DVRs and countless Internet entertainment options, including peer-to-peer videos (purloined or otherwise). Although home video executives put on a happy face about their ability to focus on a single HD disc format, there is no guarantee that they will lure tens of millions of customers into their stores—especially amidst the current economic downturn.

RECESSION OR REVIVAL?

Indeed, the euphoria about a single high-definition DVD could not have come at a worse moment. The Blu-ray victors may encounter marketing hurdles as they push their products during the DTV transition blitz. Although broadcasters are self-satisfied about their public education campaign, independent studies suggest that many Americans are still very confused about the process. Advertisements about Blu-ray—with the emphasis on its HD capabilities—may add to the chaos. How will consumers respond to an HD disc promotion when they step into an electronics store to pick up their DTV converter box (the latter of which is coupon-subsidized)? There are no answers yet.

On the positive side, at least consumers won’t face the confusing terminology of “HD DVD” in their quest for a DTV converter. They’ll just have to figure out what “Blu-ray” means.

Worse yet is the looming economic slowdown. Although high-end customers don’t wince at paying several hundred dollars for a Blu-ray player, many home video devotees may find they can survive just fine with their existing DVD equipment until the economy stabilizes.

The 600,000 HD DVD players sold in the United States (and about another half-million worldwide) are now orphans, the bane of “early adopter” consumers—but not a major problem. There’s considerable interest in whether those HD DVD customers will buy Blu-Ray equipment, or just turn to other HD program sources, such a broadcasting, cable or Internet video.

NEXT UP

Sony’s challenge now becomes generating Blu-ray sales for itself and others in the Blu-ray family. A basic standalone Blu-ray player now costs about $400, driven down to that level by competition with Toshiba’s HD DVD players. Without format competition, by summer, Blu-ray players could climb in price (some of which sold for much less). Manufacturers will claim that higher prices are justified by new features they intend to add, such as picture-in-picture, which will allow viewers to watch a video commentary at the same time they are viewing a movie.

By year-end, Sony is expected to have a Blu-ray 2.0 version that includes online connectivity—another reminder of the looming HD Internet opportunity, or competition.

As for “poor” Toshiba, it will post a restructuring charge but then log operating profits estimated at up to $450 million for dumping the HD DVD business. In fact, Toshiba spun its HD DVD suicide with a simultaneous revelation that it will invest heavily in its chip-making business: It will work with another keiretsu ally, SanDisk Corp. to build two new flash memory plants in Japan, at the cost of about $16 billion.

The chips that emerge from those plants represent yet another way that HD video could get into set-top boxes and other devices—to Toshiba’s financial benefit.

Not coincidentally, on the day after Toshiba caved in on its HD DVD format, Sony revealed that it will sell its microchip production facilities in western Japan to Toshiba for about $835 million. The plant makes chips used in PS3 game consoles and many other devices, including Toshiba products.

Although the deal had been in the works for about six months, the timing (and revelation of the price) underscored the inscrutable cross-keiretsu relationships of the electronics business. It allowed Toshiba to save some more face by enhancing its very profitable chip-manufacturing activities. And it allowed Sony to recoup a little bit of money (well, $835 million is not exactly “little”) in its drive to dominate the next generation DVD business.