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OPINION: Cost of market domination

By Marija Jaroslavskaja -- Video Business, 1/19/2009


JAN. 19 | Consumers are spending more and more on buying and renting movies online. But, says Screen Digest research analyst Marija Jaroslavskaja, the sector is dominated by hardware companies prepared to sell content at a loss to add value to and promote their core businesses, making it all but impossible for stand-alone movie stores to survive.

Online movies are on the rise—in the U.S., transactional online movie consumption (digital rental and digital retail) grew by over 135% in the last year and will more than quadruple between 2008 and 2012. The market is less developed in Europe, but growth rates will be even more dramatic. Consumers in Western Europe spent almost €45m on online digital movies in 2008 and will spend almost nine times more—€396m—in 2012.

Despite this growth, digital delivery will still contribute less than 5% of total movie spending at home (physical, digital and pay-TV) by 2012. The €221m that North American and Western European consumers spent on buying and renting movies digitally in 2008 may be small change in entertainment industry terms, but it is increasing fast, and the question remains: Who in the value chain is taking home the money?

The transactional online movie market is dominated by two key players: Apple iTunes and Microsoft’s Xbox Live Marketplace. In the U.S., these two services currently account for around 80% of all digital transactions. In Western Europe, they account for 30% of paid movie downloads, which is disproportionately high in light of their limited service roll-out: iTunes only started offering movies in the U.K. in the first half of 2008, while Xbox rolled out movies in late 2007 in U.K., France and Germany, joined by Italy and Spain in November.

Major hardware-backed stores give an instant boost to local online movie markets. For example, the Spanish market grew by over 500% in 2008 on account of the launch of the Xbox service. And as iTunes and Xbox services expand across Europe in 2009, they will kick-start new markets and, in the process, capture over 70% of Western European paid digital movie downloads by 2010.

Their popularity is a result of a mutually reinforcing dynamic between hardware and content: Consumers tend to buy content for a device they already own, while a device becomes more attractive when there is a wide selection of affordable content available for it. This is how the Apple iPod/iTunes ecosystem came to dominate the global portable media player and online music markets. The high installed base of Apple devices subsequently encouraged the take-up of the iTunes video service as well.

For the Xbox, take-up of the service is largely attributable to the ‘Trojan Horse’ effect: The device first entered consumer households as a games console. For the same reason, Screen Digest expects the movie download service linked to Sony’s PlayStation games consoles to carve out a substantial share of the market when it launches in the next few years.

Apple and Microsoft effectively subsidize their movie services to promote their core products. Apple aims to encourage hardware sales, its true money-spinner, while Microsoft seeks to promote the Xbox platform (in this case, hardware is also a loss-leading proposition, with revenue generated by licensing and the sale of third-party software).

This ‘value-add’ subsidization model is not new—this is a similar strategy to that which supermarkets use to attract consumers into stores with cheap DVDs and then upsell them to higher-margin products. And to maximize the attractiveness of their platforms, device manufacturers are prepared to pay more to acquire premium new release content from the studios than they generate by selling it.

Screen Digest estimates that in the U.K., where Apple iTunes accounts for over 65% of online movie transactions, the store made a loss of around £0.5m selling new release movies in 2008. Digging further into the Apple iTunes economics presents an interesting picture.

While consumers spent over £2m on buying new release movies on iTunes, almost all of this went to the studios, which command up to 110% of the wholesale price. The next beneficiaries in line were the Luxembourg tax office (Apple iTunes Europe is based in Luxembourg and under EU rules is taxed based on the citizenship of the company rather than the consumer) with £0.32m and credit card companies (£0.06m).

The economics play out better in the case of catalog titles—where studios take a 70% cut of the retail price—and digital rental—where their share is 60%—helping Apple to minimize the overall loss on its digital movie business. However, library titles and digital rental, while more profitable for Apple, have traditionally never been at the forefront of studio priorities when compared to the sales and profitability of new releases.

With these dominant services—which set the de facto market prices—trying to at best break even, small stand-alone services are hit by a double whammy of low margin retail prices, which they are unable to influence, and low take-up due to the lack of a device ecosystem. Moreover, small services are in danger of falling short of the minimum guarantees stipulated by studio licenses, which further inflates their unit costs. Across Western Europe, service providers made a gross loss of €0.2m from digital retail movies in 2008.

Digital rental is doing slightly better, resulting in gross revenue of €5.4m. Across the transactional movies sector, service providers made a gross profit of €5.2m from consumer spending of €44.7m. Nevertheless, over 15 online movie services in Western Europe and the U.S. have announced their closure in 2008 alone.

As the stand-alone digital movie business model becomes increasingly unsustainable, the online video services of Apple, Microsoft and Sony, backed by high hardware installed bases and ‘value-add economics,’ will continue to dominate the market. The only viable competition will come from other companies whose core businesses lie elsewhere and which are prepared to accept losses on online video delivery to drive consumers toward some other core profit center.

Video services run by supermarket chains like Carrefour or Tesco might successfully mirror their physical movie loss-leading strategy, but this is only likely to happen through careful management and execution of a digital media strategy that takes in the retailer’s entire consumer experience—adding value to the existing retail business, not taking a new direction altogether. In the U.K., for example, Tesco has already begun to link its digital music retail operation with the core supermarket business: shoppers receive special codes on supermarket till receipts that offer discounts at the Tesco Digital music store. Developing a similar strategy for movies seems like a logical next step.

The digital delivery of movies is one of a range of topics that will be addressed at Screen Digest PEVE Digital Entertainment 2009, the leading conference for the international home entertainment business, which takes place in Paris on March 12-13. For further information, visit www.peve.screendigest.com.

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