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Looking to the HD Future

25 Jan, 2008 By: Thomas K. Arnold

Studio executives are looking at 2008 with guarded optimism. The high-definition disc format war may be nearing its end, given Warner Home Video's defection from HD DVD. That means they can focus not on fighting each other, but instead on battling consumer indifference toward next-generation media, the success of which all agree is critical to the continued well-being of the home entertainment business.

“Our strategy has shifted from proving Blu-ray is the better of the two formats to sending a message to consumers that they need to convert from DVD to the next-generation format,” said David Bishop, worldwide president of Sony Pictures Home Entertainment.

He and his fellow studio leaders agree this message is critical. DVD is clearly on the decline, and the home entertainment business needs something to reinvigorate it.

Last year, many say, was 1997 all over again. A mature format (DVD) had lost its sparkle. At the same time, two emerging formats were locked in a bitter battle for succession rights, and neither one was doing anywhere near as much business as anyone had hoped.

Ten years ago, the VHS-driven rental business had peaked and was beginning to decline, while DVD and Divx, a pay-per-play variant on the much-ballyhooed disc format that had launched in March 1997, were too busy battling each other to aggressively court consumers.

In 2007, it was the DVD sellthrough business that was trending down, and Blu-ray Disc and HD DVD were locked in a bitter format war that was threatening to derail the promise of high-definition media.

As the new year dawned, then and now, studio executives focused on consumer behavior and worked to stave off further declines while lighting a fire under a new format they see as the industry's salvation.

“Our industry's biggest challenge continues to be our need to focus on the consumer and explain the benefits of high-definition media,” said Ron Sanders, president of Warner Home Video. “Unfortunately the dueling formats took the focus off the consumer.”

Packaged media falls short

For standard-DVD sales and rentals, 2007 “was a somewhat volatile year,” noted Sony Pictures' Bishop. “Our business is more like the theatrical business than it was in years past; we've always had this undercurrent of sales coming from the catalog, but as that has moved into decline, we've lost that safety net, so that when box office ebbs and flows, so do we.”

Fortunately, box office numbers were up in 2007, so the declines in home entertainment spending weren't as dramatic as everyone was predicting as recently as November, when the business was tracking about 5% behind 2006. A rash of high-profile theatricals, including the latest “Harry Potter” and “Pirates of the Caribbean” movies, hit DVD in December and brought a last-minute spending lift.

As a result, when the final numbers were presented by DEG: The Digital Entertainment Group in early January at the Consumer Electronics Show, the outcome was better than many had been fearing.

Overall consumer spending on home entertainment declined a modest 2%, to $23.7 billion, the DEG reported. Consumers spent $16 billion buying DVDs, down from $16.6 billion in 2006, while the rental business was flat at $7.5 billion.

“We started this year with the expectation that DVD sales, industrywide, would be flat, but we were slightly off,” Sanders said.

Next-generation media sales, Blu-ray Disc and HD DVD combined, contributed just $300 million to the top line — again, not exactly what studio executive had expected.

“The existence of two competing high-definition formats was a frustration,” said Lori MacPherson, GM of North America for Walt Disney Studios Home Entertainment.

Equally frustrating was a 12% decline in the average “conversion rate,” or a film's DVD sales in relation to its box office performance — a function of format maturity, MacPherson said.

Analyst Tom Adams, president of Adams Media Research, has tracked both “transition years,” as he calls them, 1997 and 2007.

“What happens at the consumer level at times like this is a general hesitancy to buy because of fear of obsolescence, both of the old format and of the new,” Adams said. “But things are more challenging this time because there are not only two formats of high-definition discs, but also the Internet — and consumers are thinking, ‘Some of my movie consumption is going to the Internet; isn't the whole world going digital, anyway?”

But 2007 wasn't all about dashed hopes and unmet expectations. The robust TV DVD category continued to hold its own, even as many popular shows concluded their “complete season” runs. Marketing ingenuity came into play in the form of pricey “complete series” sets, issued in limited quantities, that in virtually every case were a quick sellout.

There were other triumphs, as well. “Even though the sellthrough business was down, consumers found a variety of products to satisfy their needs — and it wasn't only about low prices,” said Kelley Avery, worldwide president of Paramount Home Entertainment, which thanks in large part to DreamWorks bucked the downward trend in 2007 and finished the year with 21% overall growth.

Beyond sellthrough

The rental business, too, remained remarkably resilient, perhaps because consumer DVD libraries are so full that people are once again renting what they want to watch and buying what they want to keep, as some analysts have surmised. Movie Gallery, the No. 2 rental chain that has stubbornly clung to the traditional in-store model, is a train wreck. But Blockbuster Inc. saw its fortunes rise with its embrace of the online, by-mail approach pioneered by Netflix.

Electronic delivery, meanwhile, remained a nonstarter.

“Electronic sellthrough remains an exciting but relatively small business,” MacPherson said. “It will continue to grow, but will probably not become sizeable for another seven to 10 years.”

Steve Beeks, president of Lionsgate, agrees. “We see the emergence of digital as a win-win rather than an either-or,” he said.

Warner leads the market

On the DVD market share front, Warner Home Video, together with a confederation of distributed labels that included New Line Home Entertainment and HBO Video, once again was No. 1, with an estimated 19.6% share of combined consumer purchase and rental spending, according to Home Media Magazine's market research department.

Looking to the future

What lies ahead for 2008? Assuming DVD sales remain flat, at best, or continue to decline, the great hope for the coming year is that after so many false starts, HD media sales begin to really take off, something industry leaders agree hinges on the emergence of a unified standard.

“The industry experienced its first downturn this year, so the biggest challenge in 2008 for everyone is reversing this and reigniting the category for the consumer,” said Paramount's Avery.

Sony's Bishop agrees. “I'd say we all recognize we are in a mature business, and we need to move toward the next-generation format,” he said.

In that regard, there are two encouraging signs. In what might be the only positive aspect of the format war, the existence of two rival platforms has driven down hardware prices a lot faster than they would have fallen had there been just one format in the market.

The other is that while Blu-ray Disc and HD DVD finished the year in a virtual deadlock, the tide shifted earlier when Warner abandoned its dual-format strategy and announced that after May it will support only Blu-ray. That leaves the Sony-developed format with a decided advantage.

“We expect this to exponentially help Blu-ray sales in 2008,” Beeks said. “We could see $800 million to $1 billion in Blu-ray sales this year.”

Sanders shares Beeks' optimism.

“In 2008, the industry will see [another] slight decline, but we're hopeful it is the year consumers enthusiastically embrace high-definition media,” Sanders said. “In addition, we will continue to find creative, innovative ways to package and market our catalog items. We're seeing interesting results with digital copy and consumers' perception of the increase value it provides to packaged goods. ”

Analyst Adams said recovery could take a little longer than it did in the late 1990s, when DVD, after a slow start, ignited like a rocket.

“But even then, it wasn't until 2001 that we saw huge double-digit growth rates in the business again,” he said. “And this time, we think we're not headed back to those kind of rates, ever. But we do expect the business to be growing on solid, high single digits by 2010, 2011, as the high-def bandwagon gathers steam.”

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