Will Digital Delivery Ever Pay Off for Studios?7 Mar, 2008 By: Sarah Johnson
With the packaged-media market maturing, Hollywood studios are hoping digital delivery will provide long-term revenue growth. But that won't happen without a few risks.
U.S. consumers spent $117 million buying or renting movies online last year, according to Screen Digest, while their European counterparts spent $39 million. That's about half of 1% of what each group of consumers spent on buying and renting movies (digitally and on DVD) that year. Based on current practices, by 2012 that proportion will have risen only to about 5% of total spending.
Two key reasons are behind the slow development of digital delivery: a lack of hardware-centric movie stores and the cautious approach adopted by the studios.
A successful online movie store must let consumers watch content wherever they like — not just on a PC. Transferring a movie to a portable device provides flexibility, but ultimately most consumers want to watch downloaded content on a TV.
In the United States, two device-driven stores dominate the sector. Apple's iTunes/iPod/Apple TV ecosystem monopolizes the digital retail market. Meanwhile, Microsoft's video game console-based Xbox Live Marketplace is responsible for the bulk of digital rental transactions (although Apple is now targeting this sector, too). Until late 2007 neither of these services was available in Europe.
But the studios aren't helping. When Xbox launched movies on its European Video Marketplace in December 2007, it offered titles from just one studio and in only a few countries. Studios are understandably fearful of repeating the mistakes that resulted in the dramatic decline of CD sales and the consequences for record-label revenue.
As a result, studios have been overly cautious. In the United States, they were initially reluctant to sign up to iTunes' movie-download service, afraid of creating a dominant platform and handing Apple the power to set prices. iTunes's recent announcement that it will offer movie rentals from all the studios suggests they've finally recognized they can't afford to be absent from the service.
Even in Europe — where there's no single dominant platform — studios have been slow to sign deals, and most digital stores offer content from only two or three studios. That means consumers can't access a wide variety of titles from one destination.
Even if high-definition discs breathe life into the packaged-media market in the short term, the studios need to do all they can to make digital delivery a significant revenue stream in the longer term. Screen Digest believes that the best way to achieve this is to offer content through as many outlets as possible, making it easy for users to obtain movies legally. But not all studios seem to agree. Warner Bros. had 45 deals in place with European online services by late February, while Walt Disney and 20th Century Fox had each signed just 10.
Equally important is working out which digital business models will maximize revenue. On the face of it, electronic sellthrough is the most lucrative proposition for the studios. Typically a U.S. electronic sellthrough transaction generates $14.50 in studio revenue — less than a DVD sale but without the production and packaging costs inherent in a DVD sale. But with the exception of iTunes, buy rates for such services remain low. The fact is, consumers expect downloads to be cheaper than DVDs and are unwilling to pay such high prices.
Digital rental is much more affordable for the consumer but generates only about $2.30 a turn for the studio. This means more than six digital rentals would be required to generate the same studio-level revenue as a single digital purchase. With electronic sellthrough slow to take off, studios are reassessing the digital rental window in the hopes of boosting the volume of these lower-value transactions.
In the digital business, electronic sellthrough releases tend to be day-and-date with DVD, and digital rentals have historically been delayed 45 days in the United States — and three months or more in Europe. These windows are shrinking in both the United States and Europe, and Warner has been experimenting with offering all DVD and digital versions simultaneously in the Nordics and Benelux.
Reducing the digital rental window will inevitably reduce digital retail sales — few people are likely to buy a permanent download after renting a movie. At the moment this is less problematic in Europe, where electronic sellthrough accounted for 350,000 downloads in 2007 versus 7.1 million digital rentals. In the United States, however, electronic sellthrough is the bigger business, accounting for 7.6 million transactions in 2007, compared to 5.7 million rentals, and generating more than 80% of trade-level revenue. The launch of a viable hardware-centric digital retail store in Europe — namely iTunes — could in theory make such a ratio achievable in Europe.
But if the studios encourage digital rental in the short to mid term by making it available at the same time — and perhaps even on the same platform — as electronic sellthrough, they risk jeopardizing the longer-term revenue that a viable electronic sellthrough market would generate.
Why not just let them watch for free?
A key question remains: With illegal copies of movies easily available on the Internet, will consumers pay for them at all? Music and TV shows are increasingly being offered free to users via legitimate, ad-supported services, and many viewers are likely to tolerate ads and stream a movie from a legal source if it is free.
Studios have begun to make deals with ad-supported platforms. In the United States, a limited number of Hollywood titles are available through Hulu and Gaia as well as Joost, which also offers Paramount titles in Europe. If this business model is to become a significant source of revenue, volumes need to be high. Screen Digest estimates that about 800 million full ad-supported movie streams would need to be consumed in a year to generate equivalent revenue to the digital rental business in the United States in 2012. However, given the rapid growth of free online video consumption, this figure is not unattainable; 800 million streams is only 2% of a predicted 40 billion online TV streams likely to be consumed in the United States in 2012.
The studios cannot afford to be complacent about their digital business. Online movies are a long way from being a key revenue stream, and the huge potential of the online market will remain largely untapped unless the studios adopt bolder long-term digital strategies enabling store owners to provide consumers with a large library of cheap (or free) content directly to their TV screen.
Sarah Johnson is an analyst for Screen Digest