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The view from CES: Will Blu-ray Win? (3/2/2008)

By Gary Sasaki and Chris Pedersen, Digdia

Now that Warner Bros. has announced it will exclusively support Blu-ray after its obligations to HD DVD run out on May 31, 2008, there's a growing industry consensus that Blu-ray will win. The big remaining question is how long HD DVD will continue its fight - delaying the volume sales that will come when consumers feel confident they're buying the 'winning' standard. Here are some factors you may not often read about:

Arguments for Blu-ray

First we'll list the obvious reasons that everyone points to:

1. After the Warner Bros. announcement, Blu-ray has more than two-thirds of the market share with the studio content providers.

DVD market share by studio.

2. Paramount and Universal will soon be free from contractual obligations that prevent them from supporting Blu-ray.

3. Blu-ray has a higher capacity (25/50GB) than HD DVD (15/30GB).

In addition to the above, here are some less-often mentioned reasons that influence the picture:

4. Retailers may start to see more than the expected returns of HD DVD players bought during Christmas following the press on Warner's announcement. High returns could shorten the patience of retailers. Attendees at the recent CES in Las Vegas certainly took more interest in Blu-ray after the Warner announcement.

Blu-ray booth at the 2008 CES.

HD DVD booth at the 2008 CES.

5. Studio economics favour a single format. Dual formats require twice the inventory, and take 60-80% more development effort to create interactive features for both formats.

6. In the U.S., cable television has 60%+ of the market. Blu-ray's interactive language is Blu-ray Disk Java (BD-J) and is compatible with U.S./Korean cable television's OpenCable Application Platform (OCAP, a.k.a. 'tru2way') for interactive TV. OCAP is similar to Multimedia Home Platform (MHP), which is used in Europe and other countries. HD DVD uses XML-based HDi. Cable companies like interactive features because it is their strength against satellite. In other words, if a studio writes for Blu-ray, they don't have to do much extra work to enable interactive features for cable.

7. Warner doesn't appear to have been paid to make their decision to support Blu-ray. At a Blu-ray press conference three days after the Warner Announcement, Ron Sanders, President of Warner's Home Video, explained that even $150 million would be a drop in the bucket compared to the profit impact of making the wrong decision. Their decision was based on many factors, and market success was the major one. Other studios will be influenced by Warner's logic.

Blu-ray press conference three days after Warner Announcement.

8. Not only does Blu-ray have larger capacity than HD DVD - we've only seen 25% of its potential. 50GB capacity comes with a dual-layer Blu-ray disk. Though it is little known, Blu-ray can even support 200GB eight-layer disks, and prototypes are already working. Four-layer disks will be coming out in 2009.

Arguments against Blu-ray

Here are some arguments for HD DVD and reasons why they may not be enough:

1. Currently, HD DVD disks are cheaper to produce than Blu-ray. Once volume picks up and manufacturing technology matures, differences won't be that important.

2. Programmers like HDi over Java. Programming languages are in the eye of the beholder, and studios still would like to avoid having to write interactive content twice.

3. It's cheaper to make HD DVD players that also play legacy DVDs. In time, this cost advantage will diminish as volume manufacturing lowers the cost of the overall system. In any case, both HD DVD and Blu-ray players can play legacy DVDs.

4. All HD DVD players made until now support interactive features. Since all newer Blu-ray players support so-called 'bonus' features, the window for capitalising on this advantage is now closed.

Going both ways?

LG and Samsung sell players that can play both HD DVD and Blu-ray. Hitachi is also working on this technology. These players are much more expensive than single-format players, but tend to be only slightly more expensive than buying two separate players, while providing the convenience of a single box.

Before the Warner announcement there was a healthy chance that the market would end in a stalemate. Dual-format players would get lower prices and consumers would stop worrying about which format the movie came in because they could play either one.

A good parallel is what happened to DVD+RW and DVD-RW several years ago. The two formats battled each other in the market until companies started to come out with dual format drives. Now consumers don't really worry about with type disk they use, though there are still differences between the two. But, with the Warner announcement the more likely scenario is that all commercial movies will come out in Blu-ray.

Is HD DVD dead?

HD DVD is still not dead, although it might be on 'life-support.' Media format battles are driven by profit motives. The companies on either side stand to make a lot of money if their format wins. Contributors to each format hold intellectual property such as patents, copyrights etc., design advantages in component technologies and implementations, and design expertise that they hope to monetise by selling it to the industry. Compared to the day-to-day business of selling content and devices, these business models have very high up-front investment costs, with delayed, but very lucrative returns, IF their standard wins. Because of these high costs, and the very lucrative payback that comes from being part of the winning standard, companies find it very difficult to 'throw in the towel' and give up on a standards battle.

Toshiba's Jodi Sally defending HD DVD

In this case, Toshiba also has a growing installed base and commitments for content from several studios for at least part of this year. At a press conference held two days after Warner's announcement, Toshiba's Jodi Sally admitted to 'having a bad day', but continued to defend the HD DVD format. There was no hint that they were going to give up. And, we must not forget the backing and financial reserves that Microsoft brings. They, too, continued to promote and defend HD DVD at CES.

Microsoft had a major hand in HDi. Like Microsoft's alternative proposals to OCAP, HDi is not Java based - Microsoft hates Java. Then there is the Xbox. While the Blu-ray camp likes to talk about their 3.5 million player devices in the market, 3 million of these devices are Sony PlayStations. Microsoft's Xbox 360 HD DVD Player isn't quite up to this volume (about 270k units, according to NPD Group), but they do account for around a third of the detached HD DVD players in the market. According to a Microsoft blog by one of their engineers (blogs.msdn.com/xboxteam/archive/2006/11/ 03/emergence-day.aspx), there are over 4.7 million lines of code in their HD DVD player. This code is quite an investment, and something that Microsoft would like to get a return on.

So, how will things play out?

It's impossible to say with certainty, but here's our take on the different scenarios:

1. HD DVD retrenches and wins - likelihood zero. At this point, Blu-ray has reached critical mass.

2. HD DVD quickly gives-up and Blu-ray wins - likelihood low. Toshiba and Microsoft are too vested to give up quickly.

3. HD DVD and Blu-ray co-exist - likelihood medium. Dual-format drive prices would need to come down dramatically, and do so before marketshare economics drive HD DVD to failure.

4. HD DVD fights for a long-time and Blu-ray still wins - likelihood high. With the high likelihood that all major studios will soon support Blu-ray, there is much less incentive to support HD DVD, even in a dual format drive. Consumers will just need to buy standalone Blu-ray players.

This fact leaves the PC as the main refuge for HD DVD, with Microsoft's support. But, PC manufacturers are cost-sensitive and they value storage capacity - two factors that support Blu-ray over a dual-format drive.

Even the Xbox is not totally dependent on HD DVD, because the HD DVD drive is a separate unit from the console. And, the HD DVD drive for the Xbox has not hit critical market mass. Both Toshiba and Microsoft have too much invested to give up soon. Having lost the battle over movies, they will probably shift their positioning to capitalize on HDi rather than cost. Games and PC applications may become the focus, since Toshiba feels these combined markets are equal to movie players. They must also work on helping to drive down the cost of dual-format drives for PCs.

Conclusion

Blu-ray clearly has the momentum coming out of this year's CES show. The industry overall is paying a high price for an on-going standards battle as consumers and retailers wait for clarity before investing. It will be interesting to see how long it will take before the broader industry forces profit to win over the more parochial media-format interests of the format champions. For the sake of the industry, we hope that it happens sooner rather than later. Unfortunately, we think there is a greater than 50% chance that we will still see market confusion for the 2008 holiday season, and another round of HD DVD versus Blu-ray at next year's CES.

Gary Sasaki is the President of Digdia, and Chris Pedersen is a Senior Analyst. Digdia helps companies find growth opportunities, create winning strategies and business plans in the digital entertainment value chain. Services include strategic consulting and market analysis with an understanding of the industry value chain and technologies.

www.digdia.com