So begins an LA Times story on how movie studios are re-envisioning their business models through an embrace of Internet delivery as a way to boost revenues. The movie industry learned the lesson of adapting to new technology and the disruption of traditional market structures much earlier and quicker than other media. Faced first with television, and then cable, videotapes, DVD, Blu-Ray, online streaming, etc. the industry first fought innovation, but then as it discovered the revenue potential of entering the new markets created by these innovations, it turned to embrace new media and new distribution systems for its content (movies). In many cases, the new markets not only increased demand for their products, the revenue potential at times eclipsed those possible from theater ticket sales. Particularly if you consider the costs of film distribution, and the layers of distributors and theaters taking significant chunks of the revenues generated by ticket sales.
In fact, revenues from the home entertainment market now generate more than half of all of the movie studio revenues. In the last few years, however, home entertainment revenues have dropped by as much as 40%, spurring a search for new revenue streams. There are several factors that arguably may have contributed to a decline in DVD sales. First is the development and adoption of improved formats - which you can see in the chart in the transition from VHS to DVD to Blu-ray. Historically, with the introduction of improved storage media, the improved format fails to capture the full value of the previous format. In the case of DVD vs. Blu-ray, the apparent quality difference between up-converted DVD and Blu-Ray is not significant enough to many users to justify the cost of replacing older DVDs, thus Blu-ray sales come primarily with newer releases. A related factor is that many people did major purchasing of back catalogs (i.e. favorite earlier movies) during the DVD period, inflating DVD sales numbers in the early to mid stage of the technology.
The rise of digital distribution forms, though, is arguably a stronger factor in the decline for three reasons. First, as the industry will repeatedly argue, digital media and networks facilitate piracy, which does impact sales. The estimates of the relative size of this impact are highly variable, but the fact of piracy and that it does impact home sales is fairly clear. Second, the development and diffusion of broadband digital networks has facilitated the ability to market DVD and Blu-ray content as digital files, rather than as physical copies. As online storage costs fall, and users seek the ability to view the movie content on multiple playback devices, digital sales are expected to replace some portion of physical disc sales. The slow growth of that component can be seen in the chart. The third factor, and perhaps the one with the greatest potential for long term impact, is the emergence of real-time digital streaming services. These offer an alternative to the movie fan - instead of purchasing physical discs or digital files for each desired movie, the user can access a video-on-demand rental (fee per movie), or purchase a subscription giving users access to a large catalog of movie or program offerings, again to view on demand. In those cases, you're tapping a different set of behaviors and related values, and shifting perceptions of how people prefer to access movies for private viewing. And subscription revenues and rights payments will not show up in traditional models of media sales. While the revenues subscription streaming services pay for the rights to content may well replace the total revenues lost in terms of sales, it is not clear that it comes close. (The good news is that this shift reduces demand for pirated copies).
If total revenues for subscription and VOD service rights don't replace the revenues from physical copy sales, then movie studio revenues, and arguably profits, will suffer.
There are several ways movie studios can react with slumping revenues. First, they can seek new revenue streams, and some movie companies are realizing good revenues from cross-licensing with videogaming. Second, they can look for places to reduce costs. Traditional distribution chains for movies are quite expensive - and the significant cost differential between film as a distribution medium and digital distribution is significant, and is already driving the conversion of theaters to high quality digital projection systems, just as it is driving increasing proportions of movie productions to digital. The savings from conversion to digital can offset revenue losses in other areas, at least for a time.
The other major distribution costs are in the home entertainment portion of the business - not so much in the physical reproduction (physical costs for for either DVD or Blu-ray reproduction are not that high, although pure digital distribution is cheaper) - but in the fact that movie studios have to push their product through a chain of distributors and retailers, each of whom extracts a significant chunk of retail value to cover their costs. And while that chain is fairly necessary for distribution of physical copies of movies, it is less essential for digital distribution. Already some large retailers and subscription services are dealing directly with studios, rather than acquiring content through distributors. If movie studios are willing to undertake the costs of digital distribution and processing transactions and the risk of uncertainty in value, they could capture more of the retail value for themselves.
And the studios are starting to experiment along those lines. Paramount's Rob Moore commented that "what you have now is a lot of people pursuing a lot of different paths to figure out how to reverse the (revenue) trends we've been seeing," Sony's David Bishop concurred: "It's now critical that we experiment as much as possible and determine how to build a vibrant market for collecting digital movies."
Four studios are experimenting with what they're calling premium video-on-demand, where consumers pay in the neighborhood of $30 for a high quality video-on-demand rental of top movies they can play on their home theaters before its released for retail distribution. Others are experimenting with offering movie rentals directly through Facebook, YouTube, or other non-retail focused digital outlets. Another initiative is the UltraViolet program, which will combine purchase of physical discs with access to online digital versions that permit access on multiple devices. To encourage this concept, studios are even considering offering access to digital copies of previously purchased DVDs (for a nominal fee).Warner Bros. is experimenting with developing apps as a way of exploiting additional content and product tie-ins for blockbuster movies.
Another advantage that digital distribution allows is the ability to create and exploit a variety of versions, based on factors like recency, quality, accessibility, inclusion of added content/features, etc. This can allow movie studios to continue to exploit different markets, as is currently done with distribution windows - starting with the high demand/ high value market and working your way down. Universal's Craig Kornblau put it this way
And the more they can do it themselves, the more they can keep whatever amounts that consumers are willing to pay for."I see movies going down a path over time from premium sell-through all the way to the lowest-price rentals, ... If we get digital right, consumers are going to get what they're willing to pay for."
Hollywood downloads a post-DVD future, L. A. Times