How replicators cope in a changing marketplace

It's not the best of times to be part of the disc manufacturing industry. DVD and CD has matured, BD and HD are still to come to the market, raw material costs are up and prices are stable, at best. So is it all doom and gloom? It seems not, says TIM FROST, talking to a cross-section of the industry on both sides of the Atlantic.

Replicators see the situation as more than survivable, especially as both CD and DVD numbers are holding up better than the pundits have predicted.

"The business is pretty stable," says Sean Smith, senior vice president, sales and marketing, JVC Disc America. "CD is going down a little bit but not by the percentages everyone says. People are talking about a 20% decline but we are finding that it is more like 5%."

The market for both CD and DVD has flattened off as they are both mature product categories. In the music market, CD's sales are directly proportional to the quality of the product being released - I agree entirely with Smith's ".....I'm of the school of thought that if its good it will sell." Price - as has demonstrated in the UK market where supermarket competition has dramatically cut top 50 album prices - can also lead to a revival in sales. Short of setting up their own hit girl (or boy) band, these are factors that the replicator can just hope the rest of the business sorts out; the replicators business can only reflect the success of the artists.

And the dreaded world of downloading hasn't castrated the CD market either, "We talk about iPods and downloads but they haven't had much of an affect," says Ashwin Bedi MD of the VDC group on the European side of the business. Legal downloading has filled the gap in for the demand for singles that disappeared with the demise of the 45 and never generated any real business for replicators as an optical disc format. So it's a gain for the record labels but no loss to replicators. Whether this holds up long term is open to question, with the iPod generation playing music off their PC in their bedsits, rather than off CD.

With DVD its neither good or bad news. "DVD has definitely hit a plateau. Its been 9 years already, so its been a good run especially with the pace of things today," explains Smith.

"The bottom line is most people have built their catalogue and most of the good stuff has been released," so now its down to Hollywood to deliver the hits.

This all reads well as a general theme, but the market is full of individual developments. Whilst CD business is stable at the Sonopress group, targeting the DVD business has shifted their balance of production significantly says Sven Deutschmann, CEO of Sonopress, Western Europe. "We produced over 500 million CDs and DVDs in Europe in 2005, significantly increasing unit volume. Up to now, the production ratio was roughly 2:1, but this is steadily approaching an equal production of both media.

"With continuing growth in DVDs, we will be heading for a distribution of 1:1 in the foreseeable future. In addition to the growth purely associated with DVD video, there is the fact that games and software products will more and more be distributed on DVD-ROM due to the increasing distribution of DVD ROM drives, as a substitution process."

The balance of product between DVD-5 and DVD-9 is also shifting. DVD-5 is cleaning up at the covermount and freebie markets, where the important factors are cost, manufacturability and there is no requirement for extended content. But in the mainstream business the trend is firmly towards DVD-9. This is being driven by the constant need to build value-added extras on mainstream titles and keeping the unit count down on multiple disc TV series releases.

For JVC America, the balance has moved to DVD-9 in a big way, says Smith. "The ratio is now around 75% DVD-9 and 25% DVD-5 and this is down to the value added content as most content demands the additional time , and if you are looking for a multi-disc TV series it means less discs."

Bob Freeman Crest International's Senior Vice President, Technical Operations also sees the balance moving to DVD. " I think the ratio of work is shifting to DVD. The DVD ROM market has nto really taken off yet, however it is growing year to year."

Those operating with the quality end of the market are clear that they are working on a fairly level playing field against similar competitors - not withstanding cross-licensing IP fee issues. Internationalisation at the lower end of the market has moved the production of high-volume low-value discs such as cover-mounts, giveaways and ISP discs to territories such as Eastern Europe and SE Asia. This is not fully regretted as these markets areas would do little more than keep presses running - and not contributing to profitability.

"I see a lot of cover-mount business in Europe and that is easily replaced by SE Asia competitors and others - it's a commodity that has nothing to do with profitability," comments Smith. "Are those CDs and DVDs made locally - no. But then if you are looking at a company that publishes top-line content, that is concerned about pirating, about returns at retail and about time to market then you are going to a reputable replicator."

It is also well understood that this area is not a 'level playing field' as far as payments of IP fees. There are two long-standing issues on IP payments. The first, is of cross-licensing agreements, where replicators with links to IP owners end up paying less per disc than others. Aggravating certainly - but the main vitriol is reserved for those who pay nothing, those who employ them and those let them get away with it.

Comments such as '.. if you are looking at a market that goes for the lowest price then you don't care if they are paying the royalties or not', are common and one suggestion is that some of the IP owners should '...sue a content company for using a non licensed replicator and that would scare people'. But with plants with any sort of official licensing deal amounting to at best, a quarter of the industry, and now twenty years into the life of CD and nearly ten years on for DVD, it's a rather forlorn hope that anything much is going to change.

And even if they wanted to cut corners on IP costs (which of course doesn't even come under discussion) the quality replicators, "...stick out like a sore thumb, so we have to play by the book."

So despite the costs, it is by taking full consideration of the licensing issues as part of the wider respect for content rights and protection that holds the respectable replicators in good stead with the larger content owners says Deutschmann.

"An important point to note here is that customers expect us to ensure the protection of intellectual property and product authorship. Sonopress has build up state-of-the-art equipment as well as complex processes and services in order to serve the special and most complex security needs of their customers."

But there are other more pressing commercial pressures. Prices for optical media have followed a continuous declining trend, says Bedi. "Raw materials have been going up and customers try to reduce the rates. So at the end of the day, how do any of us manage to make a business? First you make less margin and then you make sure you are taking on business where there is a margin and you are not working just for the sake of working. Then you have to structure your business so that you are running a tight ship."

Keeping tight control of overheads is a must, confirms Deutschmann, so compensating for the shortening margins "......through productivity improvements, shorter cycle times, and by generally improving our processes," and this is at a time when life is getting clearly more complicated. Replicators are required to offer more services, deal with a broader range of packaging and handle more complex demands, and all on lower volume runs, notes Deutschmann, "So we're not talking about price pressures alone, but we also have to take into account modified order structures, lower average order volumes, as well as more complex order structures that make it more difficult to plan capacities."

It is a word where no-one operates in a fat, robust environment. Everyone is the situation of having to manage labour and product schedules project-by-project, keeping cost areas such as overtime to a minimum. The old model of the pre-Christmas quarter successfully bankrolling the rest of the year is dead and gone says Smith.

"You used to ramp up for the Fall and that business would make up for the other three quarters which were slow. Those days are gone - you need at least 90% utilisation rate in the plant, watch your labour and materials cost and hope you get a rapport with your clients to work through increases in materials costs. It's a not quite the nice business like it used to be."

Freedman concurs, "It has always been a problem to maintain reasonable prices and the price of PC has exacerbated this - so you need to be more efficient and productive."

Tough times means there are going to be some casualties and consolidations. This is a feature of a mature market where the product has turned into a commodity item. That inevitably leads to a reduction in the number of smaller players and a concentration of the business into bigger groups.

"Recently you have seen replicators just closing their doors," says Freedman. "Either they are going out of business, closing facilities or offloading manufacturing/distribution entirely. It looks to me like survival of the fittest."

There's nothing new in this, the consolidation process hits all mature markets and replication is no exception. It's happened with the music labels and Smiths sees that the film and video content owners are going much the same.

"We are on the cusp of where the music labels were 25 years ago; any of the independent labels that were successful had been purchased by somebody major and the DVD business reflects this."

Michael Hosp the director of kdg's Austrian plant agrees. "Consolidation of that kind seems to be over, at least in the areas where we are active."

All this talk of consolidation leads round to the rather tough subject of the state of the equipment suppliers in this industry. Steag being subsumed into Singulus at the end of 2005 was the first major consolidation of recent times. But with the equipment supply business in 2005 running at anywhere down to 40% below 2004's already difficult times, its unlikely this will be the only consolidation.

The news from the replicators on new equipment purchases is not encouraging. VDC were popular with the suppliers recently having to invest in some new CD lines, but they were to replace capacity lost in a catastrophic fire at the end of 2005.

It prompts a very simple question for Bedi - would he have bought new lines if it wasn't for the fire. "Would we have increased our capacity if it wasn't for the fire - No. We had a fairly big capacity - more than we needed but that was to service everyone in the 4th quarter." Sonopress are moving to more DVD production over time, which is good, but JVC America's CD and DVD capacity is plenty adequate for the stable demand. "For CD and DVD there's no point," says Smith. The DVD market has matured - end of story and CD is in the same boat, so there's not reason to try and grow that business."

With CD and DVD creating stability for replicators but stagnation for equipment suppliers, all eyes turn to the new high def formats to give a new burst of energy, enthusiasm, challenge and most wished for of all - income.

Will the progress of BD and HD-DVD follow the format war between VHS and Beta , where their could only ever be one winner? Or will it parallel the DVD+R/DVD-R skirmish where both now co-exist? Or will BD/HD-DVD follow the DCC vs MD wars, where consumers ditched all the options, visiting a plague on all their houses.

At the time of writing things look optimistic for a new format. High-Def capable TVs are here, and HDTV channels are on the way, with a big push for the Beijing Olympics in 2008. HDTV demands a new carrier and BD/HD-DVD will meet that demand. With the balance of power swinging weekly between the two formats, it would be unwise to predict which will win. For the replicator, BD certainly presents a bigger process challenge than HD-DVD and probably a higher investment cost, but from a capital expenditure point of view neither are going to be cheap.

The bigger players from Technicolor downwards, have established their plans to move into the new formats this year. Sonopress' Deutschmann: "With the aspect of continuous growth in mind, we are already preparing for the next generation of high-definition and BluRay."

The JVC operation is going in the same direction, with lines going in later this year. "By the fall we will be next generation capable." this says Smith, making it very clear that this is decision is not made because of the links to a format developer, but as a purely commercial decision. "We are looking at it as a commercial venture - we have customers and there interest is there."

The independents with no links to the format developers or servicing the major content owners are not opting for a speculative investment in lines for the new formats. Lessons have been learned from the early days of DVD. Too many early investors in DVD lines ending up using them as expensive CD lines for a year before the real DVD business came in. Bedi, Hosp and Freedman expresses the seriously pragmatic approach that will see lines being installed to match demand, rather than pre-empt it.

Kdg will hold off till there is demand says Hosp. "We don't believe there is any sense in setting up production just for show - we're a manufacturing plant not a museum of technology."

"Its anybody's guess when it will become a mass production product," says Freedman. He says HD-DVD will be easier to get into so, "..we may start production for HD-DVD later this year. BD is an unknown. Ultimately this is going to be based on our customer's requirements for discs."

"We are keeping a close eye on things," says Bedi. "The only time I would invest in BD is when my customers either have a demand or demand planned. The question you asked is would I buy a line today ... the answer is No. But if my customer has a requirement - of course I will support my client."...

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