February 25, 2008
Studios Try to Save the DVD
By BROOKS BARNES and MATT RICHTEL

A winner has finally been declared in Hollywood’s high-definition DVD war. So why isn’t there more cheering?

In the 1980s, the triumph of VHS over Betamax helped develop the lucrative home entertainment market. DVDs, introduced in the 1990s, turned into an even bigger gold mine, accounting for roughly 60 percent of studio profits in recent years, analysts say. The entertainment giants have positioned high-definition DVDs as yet another blockbuster business.

But the victory of Sony’s new Blu-ray high-definition disc over a rival format, Toshiba’s HD DVD, masks a problem facing the studios: the overall decline of the DVD market. Domestic DVD sales fell 3.2 percent last year to $15.9 billion, according to Adams Media Research, the first annual drop in the medium’s history. Adams projects another decline in 2008, to $15.4 billion, and a similar dip for 2009.

So instead of celebrating the Blu-ray format — which remains a nascent business — the studios are scrambling to introduce an array of initiatives aimed at propping up the broader market. Some efforts, like the addition of new interactive features and changes in how DVDs are packaged and promoted, are intended to prevent further market erosion while nurturing Blu-ray.

But media companies are also introducing technology that they hope will solve the more difficult tasks of generating growth and delaying the obsolescence of DVD altogether.

DVD sales are sagging for various reasons, including a flooded marketplace and competition for leisure time. But the Internet is perhaps the biggest enemy.

Technology companies have watered down the DVD market by aggressively pushing Internet downloads. Apple’s iTunes now offers downloads of 500 movies and last month started renting titles like “Spider-Man 3.” Meanwhile, telecommunications providers like Time Warner and Comcast are pushing their faster broadband lines by promoting them as capable of delivering fast downloads.

Movie studios are fighting back by taking a page from the Internet playbook. Indeed, the centerpiece of the market rejuvenation effort is something 20th Century Fox calls “digital copy.” Fox DVDs, starting last month, now come with an additional disc holding a digital file of the title. Consumers can download the file to a computer in about five minutes — far less time than via the Internet — and then watch the movie there or transfer it to their iPod.

“This puts the DVD at the center of the digital revolution and returns the business to a growth trajectory,” said Mike Dunn, the president of 20th Century Fox Home Entertainment. Sony Pictures Entertainment, Universal Studios, Walt Disney and Warner Brothers are all pursuing their own versions of the idea.

Most technology consultants, while not as optimistic about the DVD’s future as Mr. Dunn, are greeting studio efforts with enthusiasm. Tom Adams, the founder of Adams Media Research, said the packaging of digital files with standard DVDs “has the real potential to steal the thunder from the Internet delivery of movies.”

But John Freeman, an industry analyst, sees the effort as a stall tactic. Although digital copies are “a step forward,” he said, that step is tantamount to Hollywood admitting that its lucrative hard-goods business is growing obsolete. Today, digital files on discs; tomorrow, mass downloading straight from the Internet.

Troubles big and small started buffeting the DVD business in 2005. First, overall sales of television shows on disc started to slip as releases lost their freshness — New to DVD! “Murder She Wrote: The Complete Eighth Season” — and consumers realized they were devoting a lot of living room space to bulky boxed sets they never watched.

Next, prices started to plummet as overall demand weakened and retailers and grocery stores turned to DVDs as loss leaders. DVDs sold for an average retail price of $15.01 last year, compared with $21.95 in 2000, according to Adams.

“Wal-Mart has indicated it is getting bored with older library titles,” said Stephen Prough, the co-founder of Salem Partners, a small investment bank that specializes in film catalogs. “When there is little to no consumer demand at a $6 price point, you’ve got problems.”

And a lingering battle among various participants in DVD marketing — hardware makers, studios and retailers — over which of two competing high-definition technologies would replace standard DVDs left consumers in limbo, analysts say. Last week, Sony’s Blu-ray finally won the battle after Toshiba threw in the towel on HD DVD.

Media companies, aware of investor concerns about the future of their cash cow, say the problems are overblown. Their position in part: DVDs will continue as a giant profit center because the Internet — despite the “marketing hocus pocus” of the telecommunications industry, in the words of one Fox executive — will remain too slow for widespread downloading to catch on for the foreseeable future.

International DVD sales are still growing, studios add, and some players do not concede that domestic growth is over. Bob Chapek, president of the home entertainment unit of Walt Disney, said that blockbusters like “Pirates of the Caribbean: At World’s End” achieve large numbers even if lesser titles are struggling. He said sales of Blu-ray discs would contribute to “a vibrant growth pattern” for the category by decade’s end.

“There is nobody worried about the consumer suddenly fleeing,” said Ronald J. Sanders, president of Warner Home Video.

Blu-ray DVDs, which sell for a 25 percent premium, will without question restore momentum to the DVD market, but there is disagreement over how much and how soon. “There is still plenty of concern at Sony, Best Buy and Blockbuster that this isn’t going to achieve the same level of success that the DVD has,” said Robert Heiblim, an industry consultant with RH Associates.

Microsoft said this weekend it would stop making HD DVD players for its Xbox 360 game system. Toshiba, reflecting on its failure with HD DVD, said the industry might be overestimating interest in a new format. Jodi Sally, Toshiba America’s vice president for DVD marketing, said consumers en masse do not feel a nagging need to upgrade.

“Our biggest competitor was that consumers seem to be satisfied” with DVDs, she said.

Studio executives dismiss that view as sour grapes, pointing to their own research. Fox, for instance, estimates that sales of Blu-ray discs will soar to nearly $1 billion in 2008, from $170 million last year. “Blu-ray growth will more than replace losses from the mature business,” said Mr. Chapek of Disney.

Disney is leaving nothing to chance, mounting an aggressive campaign to persuade consumers to upgrade to Blu-ray. Among its efforts: a Blu-ray exhibit, built to look like the Sleeping Beauty Castle at Disneyland, that tours shopping malls; Blu-ray previews on its DVDs; and a $10 rebate when consumers buy certain Blu-ray movies.

Still, the studios are hedging their bets. Home video executives are racing to “refresh” the traditional DVD to raise sales.

Some, like Warner Brothers, are getting results through more marketing. Mr. Sanders said the studio was releasing more movies on DVD and on video-on-demand services at the same time; typically the two are separated to prevent undercutting either revenue stream. “By pairing up the marketing, V.O.D. and DVD both do a lot better,” he said.

Sony is trying to milk obscure titles from its library that it previously considered unsustainable on DVD, said David Bishop, president of Sony’s home entertainment unit. Last month, it said it would make certain niche movies available to consumers through Hewlett-Packard’s manufactured-on-demand service. “It allows us to sell some of the deeper catalog that retailers would not normally carry,” said Mr. Bishop.

Over-the-top packaging stunts are also helping buoy sales. “We are trying harder to create very handsome, collectible packaging that retailers are proud to put on their shelves,” said Ken Ross, general manager of CBS Home Entertainment. CBS and its distribution partner, Paramount, recently had success with a 34-disc set, priced at $199, of the entire run of “I Love Lucy.”

Mr. Ross sees no weakness in TV shows on DVD — CBS will release 15 percent more titles this year than last — but he said the company was trying to make exclusive agreements with retailers, like a recent deal with Borders for Showtime titles.

“This business certainly isn’t as easy as it used to be,” he said.

But the Internet is perhaps the biggest enemy.