Electronic Distribution - We've Only Just Begun
As the number of electronic distribution alternatives proliferate in the home entertainment market through sell-through options such as electronic sell-through (“EST”), also known as download-to-own (“DTO”), and rental options such as video on demand (“VOD”), pay-per-view (“PPV”) and Internet based services (Netflix, AppleTV), consumers are increasingly faced with alternatives to access content in ways they have never had before. Ubiquitous access to content made possible by electronic delivery is particularly attractive to the major studios, independent and niche distributors as it enables them to have a more direct one-on-one marketing relationship with consumers; while consumers have access to content they would not otherwise have access to in a traditional physical environment. While electronic distribution platforms were traditionally hampered by many factors (pricing, technological limitations, broadband access, media window restrictions and consumer behavior) a number of initiatives and products have been launched over the past few years which appear to be accelerating the transition to electronic distribution. This, coupled with the impact of the recent economic events, clearly indicate a shift in consumer preferences and purchasing behavior. Longer term, the line between watching television or video content online via a computer versus on a traditional television set is likely to blur as viewing devices become linked through a home media server or broadband enabled TVs and accessing content shifts to utilizing search engines versus traditional channel guides.
In 2009, consumer spending on home entertainment (both physical and electronic) remained reasonably stable when compared to 2008 ($20 billion versus $21 billion respectively1, although there appears to be a shifting among the pie in terms of how consumers are allocating discretionary dollars on home entertainment product between sell-through and rental purchases on both a physical and electronic basis. This presents a potential challenge for the industry if consumers increasingly move towards a rental format as the ratio of higher contribution sell-through to lower contribution rental revenues is expected to shift via electronic distribution. It remains unclear whether consumers will demand ownership of their digital content longer term. Many industry experts have claimed that the migration to electronic distribution will result in trading “physical dollars for digital pennies” or more recently “digital dimes” as this market segment grows. A major component of this concern is that consumers will prefer the electronic rental model, yielding rental revenues of $2.99 - $4.99 per title, as opposed to downloading a title for $9.99 on average.
It is estimated that the average new release digital rental contributes $2.40 to studio revenues, while the average new release download-to-own purchase contributes $13.002. Some argue that consumers have a certain amount of money they want to spend on home entertainment and if they are utilizing electronic rental more often, this will result in a higher volume of rentals resulting in the same amount in total revenues. Others argue that consumers will not devote any more viewing time to video content than they already do and a switch in consumer behavior favoring rentals will decrease overall home entertainment spending. According to Morgan Stanley, in 1998, the average US consumer rented 36 and bought 9 videos per year, as compared to 2008, when the average consumer rented 24 and bought 10. A return to 1998 rental activity levels, which is especially possible given the impact of the recession, would mean a significant decrease in overall revenues for the industry in the long term.
With a shift in consumer behavior on the horizon, the major studios and independent distributors are licensing content for electronic downloading to internet retailers such as iTunes and Amazon.com. Adams Media Research estimates that spending for electronically downloaded content was close to $250 million in 2009, versus $90 million in 2007. While the EST market is still small relative to the US sell-through market as a whole, and the future success of this segment of the market still remains unclear, the ability to capture DTO revenues is a major focus for the industry due to high margins, opportunities to repurpose content libraries in a new format and efforts to combat piracy. Understanding and Solutions estimates that the average studio margin for online video sales is 70%, compared to a 35% margin on high definition DVDs3. It is estimated that the contribution margin to the studio for a given new release via digital sell-through is $13.00 per title, versus $11.00 for standard DVD and $12.50 for Blu-ray, as shown below:
While the DTO market has not become a significant factor in the US home entertainment market to date, a number of events are signaling that DTO should experience substantial growth in the coming years. iTunes and the launch of the video-enabled iPod, and most recently the iPad, have been major factors in increasing legal electronic downloading of movies, as well as new services from Amazon.com and via devices such as PlayStation 3. Apple announced in January 2008 that it has sold 7 million movies in the 15 months since the launch of video downloads on iTunes. BusinessWeek points out that this is 1 million more movies sold than Blu-ray sold in the first 18 months of the format4.
At the turn of the century, the DTO market was touted as the final frontier in the home entertainment segment. However, a number of obstacles have prevented download-to-own from becoming a major revenue source of the filmed entertainment industry, including piracy, pricing wars and unwillingness on the part of studios to provide content digitally. The industry acknowledged that the download-to-own market was limited in the near term as evidenced by the sale of Movielink, a video digital downloading service financed by a consortium of major studios, to Blockbuster for a reported $6.6 million in August 2007. It had been reported that the consortium had originally invested $100 million in Movielink. CinemaNow was sold to SonicSolutions in November 2008 for $3 million; shortly after, Blockbuster outsourced its Movielink and on demand services to CinemaNow. Hewlett-Packard closed its Video Merchant Services, which powered multiple online retailers’ digital downloading services, including Wal-Mart. In January 2008, Wal-Mart shuttered its downloading service after less than a year, but reinstated its commitment to this market segment with its recent purchase of VUDU. Over the past year, the industry has made strides to enhance this marketplace by making more content available for download and addressing limitations such as pricing and lack of transferability.
While most analysts agree that for the time being physical sales of DVDs will dominate the sell-through market for some time, we believe that the DTO market should grow significantly over the next few years. We have witnessed the industry react to some of the major hurdles hampering growth of the EST market, particularly pricing, transferability and content availability, which should allow for considerable consumer adoption in the coming years. Although, as noted above and below, we believe that the DTO market will grow at a slower pace than the electronic rental market, as the consumers prefer the value proposition of electronic VOD, particularly in this recessionary environment. We are forecasting DTO revenues to increase from approximately $145 million in 2008 to $576 million by 2015, a CAGR of 15%. As a percentage of total US video sell-through revenues, we expect download-to-own to grow from 2% in 2009 to 6% in 2015.
Similar to the DTO market, the traditional VOD (cable and satellite) market has not lived up to previous expectations. The industry expected cable-based VOD to grow at a rapid pace, however, since its launch in 2000, revenues have less than doubled, which is well below the growth the industry had expected. VOD through television distribution has historically been fairly limited as it was only be provided to cable and telecom subscribers and more recently on satellite. Furthermore, content availability on VOD has historically been limited, which has hindered growth in the past. To put things in perspective, the prospect for growth in VOD platforms is significant. With over 17,000 on-demand content choices, Comcast (the largest cable operator in the US) reported it delivered 4.1 billion on-demand views in 2009, up from 3.3 billion in 2008. Approximately 6% of these on-demand views were paid, generating close to $1.0 billion in revenue to Comcast. Comcast customers have viewed programming through Comcast’s on-demand platforms more than 14 billion times5.
In the earlier years of VOD and PPV, the majority of on-demand movie revenues were derived from NVOD and PPV. In 2004, 36.5% of total on-demand movie spending came from cable/telecom VOD and the other 63.5% from satellite and cable PPV and NVOD. In 2007, approximately 68% of total on-demand movie spending was generated by cable/telecom VOD, signaling the increased importance of cable-based VOD, which is now available to approximately 47 million households. The following chart highlights broadband penetration in the US:
Given the increased penetration and the prospects for telecom providing broadband services through IPTV, we anticipate continued growth in cable/telecom VOD revenues. A major hindrance for the market segment has been the availability of content, including high definition. Most new release products have historically been made available on VOD well after the DVD window has passed, as most studios were concerned about cannibalization of DVD revenues. In 2008, Warner Bros. announced that it would offer its new releases on VOD and for internet rental on the same day as the DVD is released. The studio made this decision after test markets showed that the increase in VOD revenues would more than replace any lost DVD revenues. Comcast has been actively pursuing this day-and-date initiative for the past four years, having online movies available for day-and-date in 2007 compared to 100 in 2009. Comcast believes there is strong demand for this offering as eight of its ten most popular movies on its VOD platform were day-and-date movies6.
It is largely believed that the success of the electronic distribution business will not be with cable/telecom VOD, but rather with internet services, due to lack of incentive on the part of the cable and telecom operators to focus on VOD and electronic downloading services. The contribution margins to the studios on electronic rental are considerably higher than the margins for physical rentals, as shown below:
The difference in margin between physical rentals and digital rentals is much higher than the difference for physical vs. digital sell-through. However, given the lower dollar amounts per title, digital rental requires a considerable increase in volume over digital sell-through in order to make a substantial impact.
Many analysts believe that electronic sell-through (i.e. download-to-own) will be the predominant digital delivery system in the future, rather than online rentals and VOD, which is supported by Sony’s 2009 announcement that digital delivery of movies through the PlayStation 3 have been 65% sell-through and 35% rental since the launch of the service in summer 20087. However, it is our contention that digital rental should grow at faster rates than download-to-own, just as interest in services like Netflix have outstripped physical DVDs in the past few years. Consumers may not require ownership of digital content in the way they do digital music or physical DVDs. Nonetheless, this is setting the stage for a significant debate among rights holders and delivery platforms over the best way to maximize profitability and consumer access.
Internet VOD (which we have termed herein as “digital rental”) has only recently become a significant offering with major online retailers offering digital streaming of movie content (as opposed to television shows, which have been available online for longer). Apple has licensed content from all the major studios and many independents for online digital movie rentals on iTunes. Similar offerings have been launched by Amazon.com and most recently YouTube. Subscribers to Netflix have access to its “Watch Instantly” streaming service at no additional cost and get access to 17,000 movies and television shows. We note that this is a much smaller selection than the Netflix physical DVD subscription service. Blockbuster and CinemaNow also both offer digital rentals, while Hulu supports an ad-based model with a mix of television, major studio and independent films and most recently launched a subscription service. These services have begun to show considerable traction as consumer behavior continues to shift towards ease of use and virtually unlimited choices. To give a sense of scale, in February 2010, ComScore reported that HULU had broken the one billion video viewed in a month threshold in December of 2009, the first video service to do this other than YouTube, while Netflix broke into the top twenty for the first time with 127 million views8. Comparatively speaking, according to the DEG, approximately 1.3 billion DVD units were shipped in all of 2009.
We believe that migration of internet video to television will be critical to the success of digital video delivery. Since the introduction of the first television receivers in 1939, the living room has been the focal point of in-home filmed entertainment consumption. There are a number of options for consumers to transfer digital rentals to the television set, but the web of players involved can be confusing and as the industry is changing dramatically in real time, however, there is concern among consumers about the long term viability of each player/service provider. Consumers are mostly concerned about spending a considerable amount of money on hardware and software on a device and technology that may not exist in the future.
As shown above, there are many options for consumers to choose from in order to get digital content delivered to the TV set. Currently, the xBox 360 with xBox Live is the best penetrated device able to transfer internet content to the television. The xBox has the benefit of providing its own value proposition as a game console, which provides a built-in audience for its interconnectivity services. Connecting to Netflix via the xBox does not cost any additional fees (but for the monthly Netflix subscription charge), does not require additional hardware and is relatively easy to use. One disadvantage to the Netflix service is that its streaming titles are in the post-pay TV window (but for certain tiles that are aired on Starz), making the content not as desirable as other services, although xBox Live is not limited to Netflix content.
Blockbuster offers a $99, or free with a pre-purchase of 25 rentals for $99, set-top box to deliver on-demand downloads to the television set. Unlike the Netflix service, which offers subscription streaming at no additional cost, the Blockbuster box will allow for more traditional video on demand for a rental fee and will focus on new releases.
Other popular options for web to TV connectivity include AppleTV, the $229 set-top box, that allows DTO or rental content downloaded from iTunes to be played on a television, but can only play iTunes content and the VUDU service (Wal-Mart), which can be accessed on a VUDU branded set-top box or other enabled devices. VUDU also offers approximately 16,000 movies and TV shows, including over 2,000 HD options for DTO and VOD. Apple has clearly taken the lead with providing consumers with a seamless approach to downloading content over the internet from any of their devices (iPod touch, iPhone, iPad, Mac Computers and Apple TV) which can ultimately lead the consumer to the television through a simple synchronization function.
Despite much hype, similar to the DTO and cable VOD market, digital rental has yet to meet the high growth expectations the industry touted in the past. However, we believe that digital rental should experience substantial growth in the coming years, with a CAGR of 58% from 2009 to 2015, as web to TV connectivity initiatives and broadband enabled TVs gain in popularity. While digital rental revenues as a percentage of total rental revenues is expected to remain in the minority over the short term, we anticipate this share to grow from 1% in 2009 to close to 19% by 2015:
As electronic delivery grows as a viable marketplace, we believe that it will not necessarily threaten DVD or television viewing, but simply reallocate the consumer choices and behavior. According to a study by Starz Entertainment, consumers who watch long-form content on their personal computers are more likely to rent DVDs, pay for VOD and watch live television programming than the general population. This suggests that the various distribution options have the potential to form an ecosystem of home entertainment choices for the consumer that involves cooperation from content providers, distributors and hardware manufacturers. As the digital delivery markets are all in such early stages and face many limitations, it still remains to be seen which segments consumers will eventually embrace, although we note that we are confident that, in time, digital delivery will become as mainstream to consumers as hopping into the car and heading to the rental store is today.
[2] Morgan Stanley Research, The Pause Button: As DVDs Mature, Next-Gen Platforms 2-4 Years Away from Scale. January 13, 2009.
[3] Newswire Today. (2007). High Definition Conference Report Shows Growing Importance of Sector. Retrieved November 22, 2007.
[4] BusinessWeek. (2008).iTunes Movies Outsell HD-DVD and Blu-Ray Disc. Retrieved January 17, 2008.
[5] Comcast Public Interest Filing Statement, January 2010
[6] Comcast Public Interest Filing Statement, January 2010
[7] Screen Digest. (2009). Sony to launch Playstation Network movie store in Europe. Retrieved August 19, 2009.
[8] TechCrunch. (2010). Comscore: Netflix Now A Top 20 Online Video Site. Retrieved February 3, 2010.
[9] List of companies does not include manufacturers of internet-enabled consumer electronic devices, cable operators or IPTV operators. This is not an exhaustive list but is meant to be an illustration of the growth of digital content delivery options over the internet.
