On the impact of a Blu-ray knockout

by Jean-Luc Renaud

A Happy and Prosperous New Year to all, thanking you for your support and hoping you will keep logging in as 2008 starts with a big bang, courtesy of Warner.

The Hollywood studio's decision to go Blu-ray raises the question of who will be happy and who will prosper this new year? The consumers? Sony? The BD format? Optical disc manufacturers? High definition television? Movie download services? The Chinese?

Whatever the fate of the DVD Forum-anointed HD DVD format, I find addressing the above question, far from being a facetious exercise, to be a challenging and useful endeavour. And I must admit, I like to stir the pot a little!

On competition, price and subsidy

Unlike the advent of the DVD standard where two competing consortia managed to combine their efforts into a single format prior to the format’s commercial launch ten years, today two fully formed, incompatible high definition disc formats are being offered to the consumer.

Before talking of the elusive consumer confusion, the upside of having competing formats that propose essentially identical specs elbowing for position has been to drive down remarkably quickly the price of HD hardware. An HD DVD player could be had for below $100 – barely a year into the format launch!

Even hi-def discs, when not given away with the machines, are selling for just a little over the price of standard DVDs. And we are talking of the first wave of next-gen titles.

This healthy competition was indeed acknowledged by Jeff Bewkes, President & CEO Time Warner Inc, the parent company of Warner Bros Entertainment, who now wants – needs? – to put an end to it.

Hemorrhaging money in the process of pushing competing formats into the marketplace and thus lower entry barrier into next-generation discs was a unavoidable necessity. Selling the high definition value proposition to the consumer was bound to be excruciatingly difficult on its own without the cost to the consumer complicating the exercise. The cost issue needed to become a non-issue, a goal well on its way to be achieved. This downward pressure on price stops the moment competition ceases.

Subsidies, incentivisation, bribery, whatever you want to call it, has been a key element in the marketing equation from the start of the next-generation format. The opening salvo was launched by Blu-ray manufacturer Sony DADC guaranteeing to match lower HD DVD pressing prices for an initial few years, according to comments – unchallenged – made by ex-Warner Home Video president Warren Lieberfarb at a PEVE conference two years ago.

Authoring, testing, conformance checking services have been generously provided by both camps to those publishers and independent manufacturers tipping their toes into the hi-def water. Also, HD machine makers supplied pressing lines in 'partnership' arrangements.

And then, there is the helping hands the studios received. In view of some studios’ early commitment to Blu-ray, the European Commission stepped up its investigation last July, concerned that licensing strategies of the backers of either the hi-def formats may involve exclusive deals pointing to anticompetitive activity in the industry.

Sony kept Fox on board the BD bandwagon with a subsidized price commitment for its BD discs reportedly worth $120 million. Then, there was Toshiba’s reported $150 million handout to Paramount and DreamWorks Animation to keep them firmly in the HD DVD camp.

The latest – perhaps final – act in this strategic play is the coup de pousse (trad. little push) Warner may have received to commit to BD. A founding member of the DVD Forum, Warner was closely associated with the development of HD DVD and indeed still has a contractual agreement with Toshiba to commit to the format until the end of May of this year. Rumours are now circulating that Sony may have offered the Hollywood studio incentives worth in excess of $500 million to switch allegiance mostly in the shape of guaranteed subsidised BD disc production and authoring services! If those rumours turn out to be true, in my book, this is no longer an encouragement, it is a cry for help. On this, later.

On high definition and consumer confusion

There is a widely accepted view that it is the skirmishing over two competing hi-def formats that is causing consumer confusion and, thus, is responsible for the lackluster sales performance of next-generation players. I do not subscribe to this view.

The slow take-up of next-generation discs has little to do with consumer confusion about competing formats and a lot to do with sheer ignorance about what high definition ought to be, as all research show.

While the superiority of standard 500-line DVD over 260-line VHS could be easily demonstrated and promoted in TV commercials (575 video lines), high definition cannot unless you are already equipped with the entire HD chain – content, player, screen. Short of that, the shop floor booth is the only place for a demo. Sadly, this is where consumers are let down, getting little help from retailers.

In my regular visits of major retail chains in the UK and France, I see shop floors dominated by revenue-yielding HD Ready/Full HD TVs, but virtually no hi-def player in sight, be they of the HD DVD or Blu-ray variety. To make matters worse, shelves are now full of inexpensive DVD players with up-converting capability, from the same top brands that are trying to sell you the fully-fledged hi-def machines. It is sheer irony they should then complain about format confusion!

For someone like me who is committed to, and savour, the full HD 1080p experience on a daily basis, I must admit that a good DVD upconverted produces a picture dangerously close to high-definition. So, consumers must be forgiven for believing they are already watching hi-def, and need convincing that they should fork out more money on next-gen hardware and software.

In truth, HD hardware, especially HD DVD, has reached a rock-bottom level where the price differential with an upconverting DVD player is now low enough to make entry into full HD a mostly risk-free exercise.

Lately, the battlefront has shifted in a more constructive direction. At a recent HDTV conference in Barcelona, it was heart-warming to hear both groups setting aside they difference over standards, now rallying in a common fight to educate consumers about the high definition value proposition as well as train retailers to communicate clearly that proposition. Indeed, education and training were the new battle cries heard loud and clear at Barcelona. It turned out to be short-lived.

On PlayStation 3

PS3 is Sony’s locomotive to bring Blu-ray to the marketplace. The good news is that the BD-enabled game console sells well, a multiple of the sales of HD DVD standalone players, and considerably more than its own – hardly visible – BD players.

The bad news is that the attach rate is low – barely one BD title bought per machine, against 4-5 discs for a standalone player. And with the arrival of a wider range of more enticing games than at launch, the attach rate could fall even further. This must surely exercise Sony executives' mind.

Furthermore, Sony cannot count on retailers to sell the BD features of PS3. When the console launched in the UK, the full page ads flagged the games, no word on BD movies.

Remember: At the launch of the DVD-enabled PlayStation 2 sales of DVDs were boosted, but only temporarily. The PS2 soon moved into the kids’ room, devoted to gaming. The same is happening to the PS3.

The problem is that Sony is losing money on each PS3 it sells, due in large part to the inclusion of the expensive BD capability, thus the reluctance – inability? – to bring its price further down. Also, the company cannot afford to spill more red ink in attempting to match Toshiba’s loss-leading pricing strategy for its own BD players.

Only time will tell if inclusion of a costly (and under-utilised) BD drive in the PS3 was a wise move. Offering it as an add-on unit à la Microsoft (Xbox 360), would have brought down the price of the console and, perhaps, pass on the subsidies to the standalone BD players. After all, Sony makes money from royalties on video games.

After Betamax, PSP and mp3 misses, Sony just could not add BD to the list, especially as the company is slowly recovering after massive layoffs. Failure is not an option, too much is at stake. The Warner deal can be interpreted as the price Sony is willing to pay to control the pricing strategy of its PS3 but, more importantly, of its dedicated Blu-ray players, generator of multiple-disc purchase. To achieve this objectives, the HD DVD competition had to go.

There is no question that the Warner decision is a shot of adrenalin in the BD body, especially as it may have triggered at least one of the two remaining HD DVD-only studios, Paramount, to follow suite, if one goes by a Financial Times report, though denied by the studio.

On a Blu-ray knockout

With competition out of the way, there would be no more pressure on Sony and other BD hardware manufacturers to respond to Toshiba’s aggressive price squeeze. I would not be unduly surprised if all these BD companies reach a common 'understanding' on a 'reasonable' pricing policy. The BD technology is inherently more expensive than the knocked out HD DVD while offering essentially the same benefits. Don’t expect to see many BD players below the $200-250 bar anytime soon.

This is bad new for consumers who know that entry into hi-def packaged media had been as low as $100. Even though there will be only one HD disc standard around, the higher price of BD harware might actually slow down adoption of the winning format.

The market hates a vacuum. Expect renewed activities on the Internet movie download service (and iPTV) front. Online providers will take advantage of any breathing space offered to them on a silver plate by their packaged media brethrens.

Some argue that the war is not between Blu-ray and HD DVD, but really between physical media and online distribution, and that online distribution has won. Though I disagree – packaged media' electroencephalogram is not going to go flat any time soon – no condition is permanent.

On advanced features

Above the superior picture quality, it is the uncharted territory of web connectivity and interactivity that makes me tick. Indeed, web connectivity built into the hi-res format specs is opening the door to a brand new world of interactive co-habitation between physical and online worlds, usually seen pitched against each other.

Because web connectivity, Microsoft’s HDi advanced interactivity and persistent storage are mandatory features in the HD DVD specs, it is discs in that format that to date pushed the envelope furthest – the format's product differentiation, the USP.

Blu-ray’s BD-J must surely be able to offer publishers the same level of creative innovation, but little has been on display so far. Worryingly, I do not sense much eagerness to exploit these novel advanced/online interactive features. OK, BD-J capabilities were not included in BD hardware at launch, but now, if HD DVD disappears, there may be no more incentives for BD publishers to spend money to up the ante ... and utilise Blu-ray discs' much vaunted extra storage capacity.

The Blu-ray disc version of Warner’s 300 was named the High-Def Title of the Year by Home Media Magazine at its recent High-Def Disc Awards (which was sponsored only by Blu-ray studios). The irony is that the Best Title winner is identical on both Blu-ray and HD DVD versions except the Blu-ray disc lacks the wealth of advanced features that won the HD DVD disc the Best Bonus award!

I hope – indeed implore – Blu-ray publishers to be bold and exploit to the fullest the exciting new web-connectivity and everything else that sets Blu-ray apart from standard DVD. Sharper pictures alone are not going to engage a web-savvy generation of consumers to part with their hard-earned cash on next-generation packaged media.

On Europe' pecularities

It remains to be seen how the dark clouds over HD DVD's future will play out in Europe. Whereas the US market is dominated by a handful of Hollywood majors, the multi-country, multi-lingual European continent is another ball game. A large number of smaller, independent studios shape up the market, with a share that can reach up to 45% of box office receipts in France.

HD DVD is embraced by many of these independent studios as it is the less expensive proposition. Very few of them choose to include AACS in their title releases, so no expensive key and licence costs are passed on to them by the manufacturers. In contrast, AACS is mandatory on BD.

Because an HD DVD line can be used to press standard DVDs as well, manufacturers’ capital investment for the HD DVD upgrade is lower than in the case of a Blu-ray line which can only be used to make BD discs.

Sony DADC, seen by independent manufacturers as too big a fish against which to compete, has been of late more proactive in its support to those companies wanting to offer BD services, especially in providing BD authoring services.

When assessing the potential impact of the Warner move, I caution against reading the European market situation through US lenses like most pundits indulge in doing. I believe HD DVD and Blu-ray can cohabitate for the foreseable future on this side of the Pond.

Greater Europe is nearly twice the size of the US household market. Though the potential for adopting a next-generation format is huge, Blu-ray is persona non grata in some 40% of the land mass, the Eastern European countries, where purchasing power is just too low and next-gen equipment – and discs – an unaffordable luxury.

If the cheaper HD DVD format is out of the way, don’t be surprised if the third high-definition format contender, New Medium Enterprises, will promote aggressively in these less well-off territories its red laser-based multilayer disc format, HD VMD. It offers full HD 1080p at a fraction of the cost of the bigger boys. The issue for them is increased access to content.

And what about the Chinese? Consider the following. Last September, the Chinese government unveiled its 'home grown' high-definition disc format, CH-DVD. Developed in collaboration with the DVD Forum/Toshiba, it is essentially the HD DVD format with minor adjustments that enables the Chinese government to claim it as its own.

Contractual agreements with the DVD Forum/Toshiba currently prevent CH-DVD players from being distributed outside of China to protect the HD DVD markets. But with these markets disappearing, the DVD Forum could open the floodgates for worldwide distribution of CH-DVD, sorry, HD DVD hardware. A $50 HD DVD player surely is an unbeatable proposition. Let’s call this scenario Toshiba’s Revenge.