It is rare that we ever agree with UK researcher Screen Digest. It has a customer base made up of studios and broadcasters and cannot afford to predict a future of gloom and doom without affecting its own sales. Given the underlying tenet of Faultline, which is that clinging to traditional business models is likely to lead to disaster in an all digital, IP based future, we could look at the same data as Screen Digest and perhaps reach diametrically opposite conclusions.
But given the enthusiasm with which Screen Digest pushed its contribution by its senior video analyst Helen Davis Jayalath, to the Home Entertainment Summit in June, entitled DVD and Beyond, we thought it made a good platform to analyze our differences of opinion.
We have borrowed from her slides here, all sourced as from Adams media Research, the Screen Digest US partner.
(For a full version with copies of the slides, see the pdf version of Faultline).
There is no argument with the first slide and it rather succinctly puts our point that digital formats, of which DVD is one, make the portability of content simpler, and more convenient and easier to sell. Result, a lower proportion of revenue comes from theatrical box office.
Surely the next step in digital delivery is an immediately available online stream or file, and a repeat of the two above graphs, so over a 25 year period, online will take the DVD position, DVDs shrink to take the theatrical portion and theatrical shrinks to around the level of syndications or less.
All the while the pie gets bigger, except that it is shared not just by US studios, but also by Indian, Chinese and potentially, other studio clusters. The percentage that stays loyal to the US producers is down to how they attack language issues online and whether or not they can take on the cultural backwaters of other nations and accommodate them in the product. Muslim countries hate watching films that are full of gun violence for instance, and so the US studios have to find more interesting and diverse genres.
But Screen Digest sees this outcome as unlikely. We presume that when the DVD was launched Screen Digest predicted that theatrical revenues would not fall or be dwarfed by DVD revenues, and it was proved right in the fact that theatrical revenues continued to climb, and wrong in underestimating the online effect.
At the end of the speech Jayalath concludes that physical DVD will continue to dominate home entertainment for the foreseeable future, and bases the conclusion on the graph below which shows that VoD makes up a tiny proportion of total film revenues and that internet online VoD represents less than 0.1% of total film revenues. But much the same happened with the first VHS players, and it was years before anyone knew someone that had one, and the suddenly, everyone had three.
So what happens when the Apple TV ships 20 million devices or when Sony Bravia TV sets which can view internet TV ship a further 20 million devices and watching online content just gets easier?
There is already a radical shift in TV viewing, toward the internet, and it takes time, perhaps two to three years, to build the eco-system to cater for reliable video advertising models that can facilitate this. This in turn creates an online viewing habit and then subscription or advertising funded online cinemas will emerge. All this is happening as the second replenishment cycle for DSL chips and DOCSIS 3.0 modems are being rolled out so that then the conditions will be in place for an overnight transition to high speed, online viewing.
Screen Digest doesn’t see it coming because studios wont pay for that piece of news, but it’s actually far worse.
Films currently are never viewed free to air and will never be advertising funded until after the film has already taken 97% of its lifetime revenue, so having them advertising funded around the DVD level is not a route that any film-maker wants to go down, but they will need a resolution of piracy issues, and that means finding a viable online service that reduces the attraction to piracy and competes with it. Advertising funded viewing is almost certainly the only way this can be achieved, or through low priced subscription services or very cheap unit viewing pries that undercut DVD, and that just won’t happen.
But advertising does control one core element of the film makers economic cycle. The promotional spending drives both theatrical release, and that in turn creates word of mouth interest and editorial feedback and that, combined with further advertising spend, creates the DVD event that follows the theatrical release.
So far the US studios have had to change their habits dramatically, launching in far more cinemas globally, and shortening the cycle between theatrical release and DVD product ni order to maximize and raise revenues and avoid piracy effects.
A core fact that Screen Digest knows is that every cinema in markets where there are a stable or declining number of cinema seats (so US, Europe, parts of Asia Pac), the number of people that view each sitting has been going down constantly. This is currently being balanced by third world, China and India and others, opening more cinemas in green field sites. At some stage that reduction in seats occupied per viewing will be larger than the number of new seats being opened. Result theatrical revenue reversal. This can be countered by raising prices, but all that does is accelerate the cycle.
The truth is that the US studios produce a lot of good films, but quite a lot of trash. The trash is thrust onto the public using advertising and other promotional spend and by insisting that if a cinema chain takes the hits, it must also take what should be flops, and by doing so, turn them into hits.
Result the public feel cheated, but more importantly cinema owners have lower revenues. It’s a bit like when Microsoft decided to go direct with licensing for enterprise PC customers, it was saying to HP and Dell, I’m fine, the slump in PC sales is your problem alone. And that’s what the studios are in effect saying to the cinemas.
The way out of this cycle for a cinema owner is to not be entirely dependent on the US studios for its product. Reaching into the freshly digitized back catalog, and conveying long tail (old, classic, genre driven) films, will bring them a way to revitalize their revenues, at the expense of cutting exposure of the weaker films
This is a loss of control event for the entire film channel and suddenly it will lead to confusion. If a studio spends $20 million advertising a film, but it gets less viewings due to less full screens, is it still worth the spend? And will it automatically lead to weaker DVD sales if less people see it? It might indeed.
So we come to the major issue of the day, the existence of High Definition DVDs and HD TV sets? Will this create a sudden revival in DVD revenues, which seemed to stall during 2005 and which have only marginally recovered during 2006.
Jayalath put this down to the fact that there were two influences that created the DVD revolution in films, first the shift to DVD from theatrical, with DVD growing without cannibalizing theatrical revenues, and a second event, which was the shift from rental DVDs to purchased DVDs, helped by things like the emergence of Amazon.
Sell through went from 26% of a market smaller than $20 billion to 45% of a $35 billion market in a few short years. In both cases theatrical was not cannibalized and neither was DVD rental, so it was a net growth for the business.
What bothers us here is that the Record Labels are never held up as an example. People were unhappy buying albums, but never said anything until P2P piracy came along. They wanted far bigger collections of music purchased a track at a time for a lower unit price. The Record labels forced the public into a buying habit that it did not want.
The same is happening in films. People do not want to pay for a theatrical release, rent the DVD, buy the DVD, see the film on a paid for cable channel and then go out and buy it once again in High Definition. Instead they steal it once from a pirate site, and this should be a clue to the studios.
What Screen Digest pointed out is that the business went from a CAGR of 9.5% over 7 years, to the point where studio revenues from movies dropped 5% in 2005. It says this is because the shift from rental was complete.
Box office revenues rallied in 2006, but DVD sell through has NOT recovered. What this means is that the idea that cannibalization is NOT happening is simply NOT true. Screen Digest interprets it another way.
It says that 2007 should see a return to growth and although it acknowledges that there is competition for leisure time from pay TV, DVRs, free VOD content, gaming, Internet video and it says that movies are no longer the primary driver for entertainment, and that there is emerging a cluster of major Hollywood competitors from overseas, it still thinks it will recover and get back into slightly less pedestrian growth of 4%. Talk about not being able to see the wood for the trees.
It’s important to know that Screen Digest (nor anybody else) predicted the fall coming, except that at Faultline in 2003 we were saying that once broadband lines went past the 200 million mark, the online proposition would be irresistible and it would have an inevitable affect on all forms of video entertainment.
It’s the same for researchers everywhere. IDC back in 1999 said that PC markets would grow 10% to 12 %, instead they crashed. What’s the point in telling research customers what they want to hear, when it will just help them make bad decisions? Still it’s what researchers tend to do.
Screen Digest then took on the idea of video fragmentation, pointing out that there will be more devices to play films on, such as new cable and satellite set top boxes, games consoles, laptops, portable DVD players, and PCs. That surely makes it a sellers market, and prices can be hiked.
Of course there will be around 250 million handsets that can view video, and yes they will be used to watch films. But all of this could lead studios to believe that their old markets cannot be cannibalized, and this will lead them to overprice their offerings on new formats driving people online to lookfor new sources of entertainment. What’s YouTube all about if it’s not that.
Online film won’t take off while they are more expensive than DVDs, and mobile TV film viewing will not take off if the studios expect the audience to spend on a cinema ticket, a DVD, a pay TV service, as WELL as paying for a new low resolution, mobile TV version.
What each studio needs to do is dominate the new formats to capture market share, so that when operators being offering unified, multi layered video services (watch it on your TV, your PC, your handset and keep a copy), they have enough market share to not mind the lowering of the amount of money per home per film that people will end up spending. Because the music revolution shows us that lower unit prices mean improved sales, with a lower cost of sale.
At present the studios ‘refuse’ to cannibalize their old markets by over pricing in new markets. That just means that overseas rivals will have these markets to themselves and that TV broadcasters will dominate online.
It is true however there is one more ‘big hit’ left before the entire video market has the potential to collapse into anarchy, and that’s the next three years of revenues, as consumers move to high definition films.
Here the sanity of the Screen Digest presentation slips off into the world of fantasy, claiming that HD DVD will continue to lead in standalone player sales. Already Blu-ray has overtaken HD DVD sales a fact that has been evident for most of this year.
Also Jayalath talks about PS3 cannibalizing (her favorite word perhaps) Blu-ray console sales. She then argues that people that buy PS3s will NOT buy so many disks, because they are gamers primarily.
So the argument is that people that would have bought a Blu-ray player are buying a PS3 instead. But then the argument goes on that PS3 buyers will behave like gamers and not buy any disks. But of course if the first statement is true, they are NOT really gamers and they will buy lots of disks.
Anyway the facts continue to show that the Blu-ray format is shipping more disks and has caught up parity in numbers with HD consoles, despite a price disadvantage. Oh yes and Blue-ray prices just fell.
We agree in principle that there will be a huge upsurge in sell through, starting slowly and rising through 2008 and 2009 for High Definition DVD players, except that we think HD DVD won’t last that long as a format and these will all be Blu-ray.
But she has painted a world where no-one can get films online, they all have high definition TV sets and DVD players, and that the TV broadcasting world has drifted almost entirely online, such that it will dominate the online video market, simply because the studios were told what they wanted to hear, and just refused to cannibalize their older markets.
We learned a long time ago that in technology, the businesses that are prepared to ‘eat their children,’ that is to obsolete and replace their cash cows, are the ones that can survive each technology war. And now that’s true for studios.